18

Management Report

The following management report is a combined management report as defined in Section 315 (5) of the German Commercial Code (Handelsgesetzbuch – HGB), as the future opportunities and risks of the Continental Corporation and of the parent company, Continental AG, are inextricably linked.

Glossary of Financial Terms 38 Continental AG Short Version in acc. with HGB 94 Corporate Profile 40 Other Information 96 Structure of the Corporation 40 Corporate Strategy 43 Dependent Company Report 96 Corporate Management 46 Additional Disclosures and Notes Pursuant Research and Development 49 to Section 289a and Section 315a HGB 96 Sustainability 51 Remuneration of the Executive Board 97 Employees 52 Corporate Governance Declaration Pursuant Environment 56 to Section 289f HGB 98 Social Responsibility 58

Report on Risks and Opportunities 99 Economic Report 59 Risk and Opportunity Management and General Conditions 59 Internal Control System 99 Macroeconomic Development 59 Material Risks 101 Development of Key Customer Sectors 60 Financial Risks 101 Development of Raw Materials Markets 63 R isks Related to the Markets in which Earnings, Financial and Net Assets Position 65 Continental Operates 102 Earnings Position 66 R isks Related to Continental’s Financial Position 72 Business Operations 103 Net Assets Position 74 Legal and Environmental Risks 105 Automotive Group 78 Material Opportunities 107 Development of the & Safety Division 79  Statement on Overall Risk and Development of the Powertrain Division 82 Opportunities Situation 108 Development of the Interior Division 84 Rubber Group 87 Development of the Division 88 Report on Expected Developments 109 Development of the ContiTech Division 91 Future General Conditions 109 Forecast of Macroeconomic Development 109 Forecast for Key Customer Sectors 110 Outlook for the Continental Corporation 111

38 Continental AG 2017 Annual Report Management Report Glossary of Financial Terms

Glossary of Financial Terms

The following glossary of financial terms EBITDA. Earnings before interest, tax, depreciation and amortiza- tion. In Continental’s financial reports, this abbreviation is defined as applies to the Management Report and the earnings before financial result, tax, depreciation and amortization. Consolidated Financial Statements. It equals the sum of EBIT; depreciation of property, plant and equip- ment; amortization of intangible assets; and impairment, excluding impairment on financial investments. This key figure is used to as- Adjusted EBIT. EBIT before amortization of intangible assets from sess operational profitability. purchase price allocation (PPA), changes in the scope of consolida- tion, and special effects (e.g. impairment, restructuring, and gains Finance lease. Under a finance lease, the lessor transfers the in- and losses from disposals of companies and business operations). vestment risk to the lessee. This means that the lessor bears only Since it eliminates one-off effects, it can be used to compare opera- the credit risk and any agreed services. The lessee is the beneficial tional profitability between periods. owner of the leased asset. Finance leases are characterized by a fixed basic term during which the lease may not be terminated by Adjusted sales. Sales adjusted for changes in the scope of consoli- the lessee. dation. Financial result. The financial result is defined as the sum of inter- American depositary receipts (ADRs). ADRs securitize the own- est income, interest expense, the effects from currency translation ership of shares and can refer to one, several, or even a portion of (resulting from financial transactions), the effects from changes in a share. ADRs are traded on U.S. stock exchanges in the place of the fair value of derivative instruments, and other valuation effects. foreign shares or shares that may not be listed on U.S. stock ex- The financial result is the result of financial activities. changes. Free cash flow. The sum of cash flow arising from operating activi- Capital employed. The funds used by the company to generate its ties and cash flow arising from investing activities. Also referred to sales. as cash flow before financing activities. Free cash flow is used to as- sess financial performance. Changes in the scope of consolidation. Changes in the scope of consolidation include additions and disposals as part of share and Free cash flow before acquisitions. The sum of cash flow arising asset deals. Adjustments were made for additions in the reporting from operating activities and cash flow arising from investing activi- year and for disposals in the comparative period of the prior year. ties before acquisitions of companies and business operations. Free cash flow before acquisitions is used to assess financial perfor- Continental Value Contribution (CVC). The absolute amount of mance. additional value created. The delta CVC represents the change in absolute value creation compared to the prior year. Delta CVC al- Gearing ratio. Net indebtedness divided by equity. Also known as lows us to monitor the extent to which management units generate the debt to equity ratio. This key figure is used to assess the financ- value-creating growth or employ resources more efficiently. ing structure.

The CVC is measured by subtracting the weighted average cost of Gross domestic product (GDP). A measure of the economic per- capital (WACC) from the return on capital employed (ROCE) and formance of a national economy. It specifies the value of all goods multiplying this by the average operating assets for the fiscal year. and services produced within a country in a year. The WACC calculated for the Continental Corporation corresponds to the required minimum return. The cost of capital is calculated as Hedging. Securing a transaction against risks, such as fluctuations the weighted average ratio of the cost of equity and borrowing in exchange rates, by entering into an offsetting hedge transaction, costs. typically in the form of a forward contract.

Currency swap. Swap of principal payable or receivable in one IAS. International Accounting Standards. Accounting standards de- currency into similar terms in another currency. Often used when veloped and resolved by the IASB. issuing loans denominated in a currency other than the functional currency of the lender. IASB. International Accounting Standards Board. Independent standardization committee. Derivative instruments. Transactions used to manage interest rate and/or currency risks. IFRIC. International Financial Reporting Interpretations Committee (predecessor of the IFRS IC). Dividend payout ratio. The ratio between the dividend for the fiscal year and the earnings per share. IFRS. International Financial Reporting Standards. The standards are developed and resolved by the IASB. In a broad sense, they also EBIT. Earnings before interest and tax. In Continental’s financial re- include the IAS, the interpretations of the IFRS IC or of the prede- ports, this abbreviation is defined as earnings before financial result cessor IFRIC as well as the former SIC. and tax. It is the result of ordinary business activities and is used to assess operational profitability.

Continental AG 2017 Annual Report Management Report Glossary of Financial Terms 39

IFRS IC. International Financial Reporting Standards Interpretations Rating. Standardized indicator for the international finance mar- Committee. kets that assesses and classifies the creditworthiness of a debtor. The classification is the result of an economic analysis of the Interest-rate swap. The exchange of interest payments between debtor by specialist rating companies. two parties. For example, this allows variable interest rates to be exchanged for fixed interest or vice versa. Research and development expenses (net). Research and devel- opment expenses (net) are defined as expenses for research and Net indebtedness. The net amount of interest-bearing financial lia- development less reimbursements and subsidies that we received bilities as recognized in the balance sheet, the positive fair values of in this context. the derivative instruments, cash and cash equivalents, as well as other interest-bearing investments. This figure is the basis for calcu- Return on capital employed (ROCE). The ratio of EBIT to average lating key figures of the capital structure. operating assets for the fiscal year. ROCE corresponds to the rate of return on the capital employed and is used to assess the company’s Operating assets. The assets less liabilities as reported in the bal- profitability and efficiency. ance sheet, without recognizing the net indebtedness, sale of trade accounts receivable, deferred tax assets, income tax receivables SIC. Standing Interpretations Committee (predecessor to the and payables, as well as other financial assets and debts. Average IFRIC). operating assets are calculated as at the end of the quarterly peri- ods and, according to our definition, correspond to the capital em- Tax rate. The ratio of income tax expense to the earnings before ployed. tax. It can be used to estimate the company’s tax burden.

Operating lease. A form of lease that is largely similar to rental. Weighted average cost of capital (WACC). The weighted average Leased assets are recognized in the lessor’s balance sheet and cost of the required return on equity and net interest-bearing liabili- capitalized. ties.

PPA. Purchase price allocation. The process of breaking down the Working capital. Inventories plus trade accounts receivable less purchase price and assigning the values to the identified assets, lia- trade accounts payable. It does not include receivables from and bilities and contingent liabilities following a business combination. liabilities to related parties or sale of trade accounts receivable. Subsequent adjustments to the opening balance sheet – resulting from differences between the preliminary and final fair values at the date of initial consolidation – are also recognized as PPA.

40 Continental AG 2017 Annual Report Management Report Corporate Profile

Corporate Profile Structure of the Corporation

The structure of our corporation is geared Our customers come primarily from the (origi- nal equipment) – with a 72% share of our consolidated sales – as toward sustainable value creation. well as from various key industrial sectors (e.g. railway engineering, machine and equipment engineering, and mining) and the end- Market- and customer-oriented corporate structure user market. We deliver high-quality, innovative and established Founded as Continental-Caoutchouc- und Gutta-Percha Compagnie products, systems and services around the world. Focusing on the in 1871, Continental-Aktiengesellschaft (AG), headquartered in market and on customers is a key success factor. Our global corpo- , , is now the parent company of the Continental rate structure is based upon a balance of decentralized structures Corporation. The Continental Corporation comprises 527 compa- and central functions. In this context, central management areas nies, including non-controlled companies, in addition to the parent and operating activities are closely aligned. This means that we can company Continental AG. The Continental team is made up of respond quickly and flexibly to market conditions and our custom- 235,473 employees at a total of 554 locations in 61 countries. ers’ requirements, while ensuring that the Continental Corporation Here, the postal addresses of companies under our control are sustainably creates value. defined as locations. The corporation is divided into the Automotive Group and the Rub- The Executive Board of Continental AG has overall responsibility for ber Group, which in the year under review comprised five divisions management. The divisions each have their own Executive Board with 29 business units. A division or business unit is classified ac- member who represents them. With the exception of Corporate cording to products, product groups and services or according to Purchasing, the central functions are represented by the chairman regions. Differences result primarily from technological product re- of the Executive Board, the chief financial officer and the Executive quirements, innovation and product cycles, the raw materials base, Board member responsible for Human Relations. They take on the and production technology. Other factors include economic cycles, functions required on a cross-divisional basis to manage the corpo- competitive structure and the resulting growth opportunities. The ration. These include, in particular, finance, controlling, compliance, divisions and business units have overall responsibility for their law, IT, sustainability, quality and environment. business, including their results.

The effective and efficient cooperation of divisions, business units and central functions is governed by our “Balance of Cooperation.” It defines the framework of our activities across organizational, hier- archical and geographic boundaries and promotes our corporate culture on the basis of our corporate values: Trust, For One Another, Freedom To Act and Passion To Win.

Continental AG 2017 Annual Report Management Report Corporate Profile 41

Structure of the corporation Continental Corporation Sales: €44.0 billion; Employees: 235,473

Automotive Group Rubber Group Sales: €26.6 billion; Employees: 134,286 Sales: €17.5 billion; Employees: 100,749

Chassis & Safety Powertrain Interior ContiTech Sales: €9.8 billion Sales: €7.7 billion Sales: €9.3 billion Sales: €11.3 billion Sales: €6.2 billion Employees: 47,788 Employees: 40,492 Employees: 46,006 Employees: 53,811 Employees: 46,938

Automotive Group: Rubber Group: The Chassis & Safety division develops, produces and markets in- The Tire division is known for maximizing safety through short telligent systems to improve driving safety and vehicle dynamics. braking distances and excellent grip as well as reducing fuel con- The direction for the division is clear: The future of mobility leads to sumption by minimizing . Tires are the vehicle’s automated driving. Integral active and passive safety technologies only link with the road. They have to transmit all forces onto four and products that support vehicle dynamics provide greater safety, areas of the road surface that are roughly the size of a postcard. comfort and convenience. The Chassis & Safety division is divided In critical situations, it is the technology level of the tires that deter- into four business units: mines whether a vehicle is able to stop in time or stay in the cor- rect lane during cornering maneuvers. 29% of sales in the Tire › Advanced Driver Assistance Systems division relates to business with vehicle manufacturers, and 71% › Hydraulic Brake Systems relates to the replacement business. The division is divided into › Passive Safety & Sensorics six business units: › Vehicle Dynamics › Passenger and Light Truck Tire Original Equipment › Passenger and Light Truck Tire Replacement Business, The Powertrain division combines innovative and efficient sys- EMEA (Europe, the Middle East and Africa) tem solutions for the powertrains of today and tomorrow. In line › Passenger and Light Truck Tire Replacement Business, with the central theme of clean power, the products make driving The Americas (North, Central and South America) more environmentally compatible and cost-efficient, while also en- › Passenger and Light Truck Tire Replacement Business, hancing comfort, convenience and driving enjoyment. The division APAC (Asia and Pacific region) is divided into five business units: › Commercial Vehicle Tires › Two-Wheel Tires › Engine Systems › Fuel & Exhaust Management › Hybrid The ContiTech division develops, manufactures and markets func- › Sensors & Actuators tional parts, intelligent components and systems made of rubber, › Transmission plastic, metal and fabric for machine and plant engineering, mining, agriculture, the automotive industry, and for other important sec- tors. 51% of sales in the ContiTech division relates to business with The Interior division specializes in information management. It vehicle manufacturers, and 49% relates to business with other in- develops and produces information, communication and network dustries and in the replacement market. ContiTech has been reor- solutions for and commercial vehicles. This enables and opti- ganized with the goal of making its business processes faster and mizes the control of the complex flow of information between the more interconnected. Since the beginning of 2018, ContiTech has driver, passengers and the vehicle as well as mobile devices, other comprised seven business units, instead of the previous nine: vehicles and the outside world. To achieve this, the division is in- volved in cross-sector collaborations with leading companies. It is › Air Spring Systems divided into five business units: › Benecke-Hornschuch Surface Group › Conveyor Belt Group › Body & Security › Industrial Fluid Solutions › Commercial Vehicles & Aftermarket › Mobile Fluid Systems › Infotainment & Connectivity › Power Transmission Group › Instrumentation & Driver HMI › Vibration Control › Intelligent Transportation Systems

42 Continental AG 2017 Annual Report Management Report Corporate Profile

Interconnected value creation than 40% of the corporation’s purchasing volume of production Research and development (R&D) takes place at 78 locations, pre- materials. Furthermore, mechanical components account for about dominantly in close proximity to our customers to ensure that we a quarter of production materials. and oil-based can respond flexibly to their various requirements and to regional chemicals such as synthetic rubber and carbon black are key raw market conditions. This applies particularly to the R&D projects of materials for the Rubber Group. The total purchasing volume for the Automotive Group and the ContiTech division, both of which these materials amounts to around a sixth of the total volume for have a decentralized organizational structure. The product require- production material. For more information, see the Development of ments governing tire business are largely similar all around the Raw Materials Markets section in the Economic Report. world. They are adapted according to the specific requirements of each market. In this respect, R&D has a largely centralized structure In line with our strategy, production and sales in the divisions of in the Tire division. Continental invests about 7% of sales in R&D the Automotive Group and in the ContiTech division are organized each year. For more information, see the Research and Develop- across regions. Our tire production activities, in which economies ment section. of scale play a key role, are represented with major locations in the three dominant automotive markets in terms of production and ve- Continental processes a wide range of raw materials and semi- hicle numbers, namely Europe, the U.S.A. and . Low produc- finished products. The purchasing volume in the reporting year tion costs coupled with large volumes or high rates of regional was €29.6 billion in total, €20.2 billion of which was for production growth constitute key success factors. Sales activities in the Tire materials. The Automotive Group uses primarily steel, aluminum, division are performed worldwide via our dealer network with spe- precious metals, copper and plastics. Key areas when it comes to cialty tire outlets and franchises as well as through tire trading in purchasing materials and semifinished products include electronics general. and electromechanical components, which together make up more

Globally interconnected value creation

R&D Purchasing Production Sales & Distribution

Innovative Diverse Global Local €3.1 billion in expenditure €29.6 billion in volumes 233 locations €44.0 billion in sales

Continental AG 2017 Annual Report Management Report Corporate Profile 43

Corporate Strategy

Our strategy comprises seven dimensions tematic, interconnected strategy process. We are thus aligning the activities for achieving the goals of individual units with our vision that complement each other. and the seven strategic dimensions. At the same time, we are identi- fying potential contradictions of our vision and our seven strategic We are continually improving our management and work pro- dimensions as well as commonalities and opportunities. We are cesses. For example, in the reporting year, we began establishing deriving measures from this so as to align the content of our work the planning and management system Hoshin Kanri (Japanese for more closely with our strategic dimensions. policy management) for the entire company. This is about aligning the activities and efforts of all employees worldwide with our Seven strategic dimensions for enhancing the value of the shared vision and our mutual goals. corporation on a sustainable basis Our seven strategic dimensions complement one another. They In this way, we are organizing the interconnection and the interplay are geared toward sustainably creating value for all stakeholders of our various target levels: the strategic goals of the organization and ensuring the future viability of the company. as a whole with their associated initiatives and dimensions and the goals of individual organizational units. Our vision gives us the 1. Value creation – enhancing the value of the corporation on a long-term orientation for this planning process. In the short term, long-term basis we are accelerating our development with the aid of three crucial For us, enhancing the value of the corporation on a long-term basis growth forces in relation to customers, processes and employees. means sustainable success while taking into consideration the cost of capital. Our target is at least 20% ROCE. We reached this target The Hoshin Kanri planning system means that all managers and again in 2017. After 20.0% in 2016, we achieved 20.6% in the re- employees in the entire company – companies and business units porting year. as well as divisions and corporate functions – are involved in a sys-

44 Continental AG 2017 Annual Report Management Report Corporate Profile

Continental Value Contribution (CVC) € millions ROCE % We have production locations in 38 of 61 countries in which we are represented. We again expanded our production in various divi- sions in 2017, for example by increasing tire production capacity in

20.9% 20.6% Portugal and beginning the expansion of tire production as well as 20.0% 20.0% >20.0% 19.4% opening a new plant for coated fabrics in China. The construction of a tire plant began in Thailand. We opened a research and devel- 2,350 opment center in Silicon Valley in the U.S.A. 2,145 2,045 We are still working on being able to count one of the Asian manu- 1,580 1,673 facturers among our five largest automotive customers as well. We aim to achieve this with a high degree of localization. In the mean- time, two Asian manufacturers are now among our ten largest cus- tomers.

5. Balanced customer portfolio – balance between automotive 2013 2014 2015 2016 2017 Target 2020 and other industries Our dependency on the automotive economy is to be reduced by way of a balanced customer portfolio. To this end, we want to in- 2. Regional sales balance – globally balanced distribution of sales crease business in industries outside of the automotive original- We want to achieve a globally balanced distribution of regional equipment sector while at the same time achieving further growth sales, which will allow us to become less dependent on individual with carmakers. In the medium to long term, we want to lift the regional sales markets and on market and economic fluctuations. share of sales with end users and industrial customers outside of To accomplish this, we are taking advantage of the opportunities the automotive original-equipment sector toward a figure of 40%. available to us on the growing markets in Asia and North America, while bolstering our strong market position in Europe. We aim to This will be based mainly on our Tire and ContiTech divisions. Our gradually increase the share of our consolidated sales in the Asian activities in the field of software-based services for the end-user markets to 30%. In China we want to grow at an above-average rate market will also make an increasing impact. Examples include ad- in the next few years. The total share of our sales in the North and vanced traffic management, intelligent payment systems, mainte- South American markets should be maintained at 25% or more. nance management and new technologies that go beyond the vehicle. In 2017, we achieved a 22% share of sales in Asia. The share of our sales in the North and South American markets was 28% in total. Despite our efforts, the share of sales with end users and industrial customers remained broadly stable at 28%. The reasons for this in 3. Top market position – among the three leading suppliers in the reporting year included the above-average growth in our Auto- all relevant markets motive divisions, which was seven percentage points higher than We want to be among the world’s three leading suppliers in terms global vehicle production. of customer focus, quality, and market share in the long term. This will enable us to plan our future based on a leading position and 6. Technological balance – combination of established and thereby play a major role in advancing technological development pioneering technologies in individual sectors. Our product portfolio should consist of a mix of profitable as well as viable established and pioneering technologies. We set and fol- In terms of sales in their respective markets, the Automotive Group’s low new trends and standards in high-growth markets and market divisions and the ContiTech division are among the leading provid- segments. On our established core markets, we ensure that our ers with the majority of products. In the tire business, we are num- position as one of the leading automotive suppliers and industrial ber four in the world over all, while we are also in top positions in partners keeps on developing. This allows us to be represented and individual segments and markets in this area. competitive in all phases of the respective product life cycles.

4. In the market for the market – high degree of localization Alongside technologies for optimizing the combustion engine, we Our global business model is based on a high degree of localiza- are developing new technologies that allow all-electric driving for tion, with numerous product applications developed and produced limited periods or continuously. locally. This is the best way to meet the respective market condi- tions and the requirements of our customers. The aim is for at least We are expanding our portfolio with software-based and mobility eight out of ten application developments to be carried out locally, services that complement existing products and benefit our cus- and for the percentage of local production to be just as high. Our tomers. development and production teams worldwide enable us to offer solutions and products for high-quality cars and affordable vehicles, In order to strengthen the innovation and agility so essential in as well as customized industrial applications. At the same time, we times of digital transformation, we set up a special program for co- are purchasing locally – insofar as this is possible and cost-effective operating with startups last year. The potential of employees and – as well as marketing locally. external startups is thus to be utilized worldwide. It is a special and

Continental AG 2017 Annual Report Management Report Corporate Profile 45

comprehensive program with a separate company that links the tude toward Continental. Participation is voluntary and anonymous. startup world to Continental – co-pace GmbH. The startup program In previous years, we invited all employees around the world to comprises three elements: In the “incubator,” our employees are take part every two to three years. Since 2017, the survey has been given the opportunity to develop new business concepts in a start- carried out annually with a representative sample of the workforce. up environment. In the “cooperation program,” external startups are This enables us to identify potential improvements faster and im- brought together with Continental to develop and trial applications plement changes more quickly. on a prototype basis. The third element is “corporate venture capi- tal,” where investments are made in selected startups. In the reporting year, we asked around a quarter of employees for their opinion on 50 questions. 74% of these employees took part 7. Great people culture – a culture of inspiration in the survey. The results included the following: employee loyalty We aim to foster an inspiring management culture, in which our to the company is very positive; 84% of respondents are proud to employees can enjoy demonstrating their full commitment and work at Continental; 86% support our corporate values: Trust, For achieving top performance. We promote a culture of trust and per- One Another, Freedom To Act and Passion To Win. At the same sonal responsibility in all divisions and functions, one in which we time, 63% stated that these values are practiced on an everyday openly deal with and tolerate our mistakes and turn them into les- basis – a decline of six percentage points compared to the 2015 sons learned. Our working conditions are intended to make it easy survey. However, it should be noted that in our survey a neutral for our employees to focus on what is important and to strike the answer is classified as a negative opinion. Leadership was evalu- right work-life balance. We keep in regular contact with our employ- ated positively. 84% of the employees surveyed agreed that their ees, for example through our worldwide surveys. These give our superiors treated them with respect. Two-thirds of the respondents employees the chance to tell us about how satisfied they are in feel encouraged to give their best and to question traditional work- general, the quality of management in the company and their atti- ing methods.

46 Continental AG 2017 Annual Report Management Report Corporate Profile

Corporate Management

A core component of our strategy is the › The return on capital employed (ROCE) represents the ratio of ongoing enhancement of the company’s these two calculated values. Comparing a figure from the state- ment of income (EBIT) with one from the statement of financial value. position (capital employed) produces an integral analysis. We deal with the problem of the different periods of analysis by calculat- ing the capital employed as an average figure over the ends of Value management quarterly reporting periods. ROCE amounted to 20.6% in 2017, Key financial performance indicators for Continental relate to the once again significantly exceeding the cost of capital. development of sales, capital employed and adjusted EBIT margin, as well as the amount of capital expenditure and free cash flow. › The weighted average cost of capital (WACC) is calculated to de- To allow us to use the financial performance indicators for manage- termine the cost of financing the capital employed. Equity costs ment purposes as well, and to map the interdependencies between are based on the return from a risk-free alternative investment these indicators, we summarize them as key figures as part of a plus a market risk premium, taking into account Continental’s spe- value-driver system. Our corporate objectives center on the sus- cific risk. Borrowing costs are calculated based on Continental’s tainable enhancement of the value of each individual business unit. weighted-debt capital cost rate. Based on a multi-year average, This goal is achieved by generating a positive return on the capital the weighted average cost of capital for our company is about employed in each respective business unit. At the same time, this 10%. return must always exceed the equity and debt financing costs of acquiring the operating capital. It is also crucial that the absolute › Value is added only if ROCE exceeds the weighted average cost contribution to value (Continental Value Contribution, CVC) in- of capital (WACC). We call this value added, produced by subtract- creases year for year. This can be achieved by increasing the return ing WACC from ROCE multiplied by average operating assets, the on capital employed (with the costs of capital remaining constant), Continental Value Contribution (CVC). lowering the costs of capital (while maintaining the return on capi- tal employed), or decreasing capital employed over time. The per- › In the long term, enterprise value by our definition will increase formance indicators used are EBIT, capital employed, and the only if the CVC shows positive growth from year to year. weighted average cost of capital (WACC), which is calculated from the proportional weight of equity and debt costs. ROCE by division (in %) 2017 2016 Continental Value Contribution (CVC) € millions ROCE % Chassis & Safety 19.9 13.1 Powertrain 13.2 12.5 Interior 14.9 12.6 20.9% 20.6% 20.0% 20.0% Tires 35.0 40.8 19.4% ContiTech 13.9 13.5 Continental Corporation 20.6 20.0 2,350 2,145 2,045

1,580 1,673

2013 2014 2015 2016 2017

› EBIT is calculated from the ongoing sales process. The figure is the net total of sales, other income and expenses plus income from equity-accounted investees and from investments but be- fore financial result and income tax expense. Consolidated EBIT amounted to €4.6 billion in 2017.

› Capital employed is the funds used by the company to generate its sales. At Continental, this figure is calculated as the average of operating assets as at the end of the quarterly reporting periods. In 2017, average operating assets amounted to €22.2 billion.

Continental AG 2017 Annual Report Management Report Corporate Profile 47

Financing strategy Composition of gross indebtedness (€4,090 million) Our financing strategy aims to support value-adding growth of the Continental Corporation while at the same time complying with an equity and liabilities structure adequate for the risks and rewards of Other bank our business. Bonds 2,639 860 liabilities

The corporate function Finance & Treasury provides the necessary financial framework to finance corporate growth and secure the Syndicated 0 loan long-term existence of the company. The company’s annual invest- ment requirements will be around 7% of sales in the coming years. Other The reasons for this are the continuing increase in incoming orders 591 indebtedness in the Automotive Group and the successful implementation of Vision 2025 in our Tire division, which will mean the expansion of tire production capacity, particularly in North America and Asia.

Our goal is to finance ongoing investment requirements from the The revolving credit line had not been utilized as at December 31, operating cash flow. Other investment projects, for example acqui- 2017. Around 63% of gross indebtedness is financed on the capi- sitions, should be financed from a balanced mix of equity and debt tal market in the form of bonds maturing between July 2018 and depending on the ratio of net indebtedness to equity (gearing ra- September 2020. The interest coupons vary between 0.0% and tio) and the liquidity situation to achieve constant improvement in 3.125%. The repayment amounts are €750.0 million in 2018 and the respective capital market environment. In general, our goal €500.0 million in 2019. In 2020, the amounts are €600.0 million is to continue to keep the gearing ratio below 20% in the coming and €750.0 million. In addition to the forms of financing already years and ensure that it does not exceed 60% in general. If justi- mentioned, there were also bilateral credit lines with various banks fied by extraordinary financing grounds or specific market circum- in the amount of €1,556.5 million as at December 31, 2017. In stances, we can rise above this maximum level under certain condi- addition to finance leases, Continental’s other corporate financing tions. The equity ratio should exceed 35%. In the year under review, instruments currently include sale-of-receivables programs and the equity ratio was 43.5% and the gearing ratio 12.6%. commercial paper programs.

Our gross indebtedness should be a balanced mix of liabilities to Maturity profile banks and other sources of financing on the capital market. For Continental always strives for a balanced maturity profile of its short-term financing in particular, we use a wide range of financing liabilities in order to be able to repay the amounts due each year instruments. As at the end of 2017, this mix consisted of bonds from free cash flow as far as possible. Other than short-term maturi- (65%), syndicated loan (0%), other bank liabilities (21%) and other ties, which are usually rolled on to the next year, the repayment indebtedness (14%) based on the gross indebtedness of €4,090.0 of the bonds amounting to €750.0 million and €500.0 million due million. The committed volume of the syndicated loan, which con- in July 2018 and February 2019 is on the agenda for 2018 and sists of the revolving tranche, remained unchanged at €3.0 billion. 2019. The tranche will run until April 2021. The financing mix will not change significantly. Maturities of gross indebtedness (€4,090 million)

The corporation strives to have at its disposal unrestricted liquidity 2,072 of about €1.5 billion as at the end of the reporting period. This is supplemented by committed, unutilized credit lines from banks in order to cover liquidity requirements at all times. These require- 1,363 ments fluctuate during a calendar year owing in particular to the seasonal nature of some business areas. In addition, the amount of liquidity required is also influenced by corporate growth. Un- restricted cash and cash equivalents amounted to €1,726.7 mil- 577 lion as at December 31, 2017. There were also committed and unutilized credit lines of €3,686.8 million. 9 69

Gross indebtedness amounted to €4,090.0 million as at Decem- 2018 2019 2020 2021 from 2022 ber 31, 2017. Key financing instruments are the syndicated loan with a revolving credit line of €3.0 billion that has been granted until April 2021 and bonds issued on the capital market.

48 Continental AG 2017 Annual Report Management Report Corporate Profile

Continental’s credit rating unchanged In the reporting period, Continental was rated by the three rating agencies, Standard & Poor’s, Fitch and Moody’s, each of which maintained their credit ratings for Continental AG during 2017.

Continental’s credit rating

December 31, 2017 December 31, 2016 Standard & Poor’s1 Long term BBB+ BBB+ Short term A-2 A-2 Outlook stable stable Fitch2 Long term BBB+ BBB+ Short term F2 F2 Outlook stable stable Moody’s3 Long term Baa1 Baa1 Short term no rating no rating Outlook stable stable

1 Contracted rating since May 19, 2000. 2 Contracted rating since November 7, 2013. 3 Non-contracted rating since February 1, 2014.

Continental AG 2017 Annual Report Management Report Corporate Profile 49

Research and Development

Our core topics are automated driving, R&D center in Silicon Valley opened Our global technology network was expanded in April 2017 with electric mobility, connectivity, digitalization the opening of a research center in San José, Silicon Valley, Califor- and urbanization. nia, U.S.A., where up to 300 experts from various operational and strategic areas of Continental are to work on the mobility of the fu- ture. The focus is on projects related to automated driving, electric Continental stands for mobility, which we are creating and shaping mobility, connectivity and mobility services. with our ideas and solutions for our customers in various industries. Activities in the area of research and development (R&D) therefore Software-based solutions play a significant role in these areas, along have a high level of strategic relevance. At the same time, we keep with the processing of large amounts of data and using artificial in- our social responsibility in mind, which is why all future issues and telligence. At the same time, the center provides a direct interface research activities are also considered and defined in terms of be- with our customers and with startups in California, U.S.A. The 6,000- ing safe, clean and intelligent. square-meter research center comprises cutting-edge laboratories, workshops and offices. When developing our products, systems, solutions and services, we systematically implement a corporation-wide technology strategy Continental has been represented in Silicon Valley for many years. based on our core topics: automated driving, electric mobility, con- The Intelligent Transportation Systems (ITS) business unit has been nectivity, digitalization and increasing urbanization. based there since 2014. All areas of Continental cooperate in an in- terdisciplinary and collaborative manner in San José. The management body responsible for adapting and evolving the long-term technology strategy is the Executive Board. At the Execu- Further expansion of international research network tive Board technology review meetings – which are held regularly We continued expanding our international research network inter- several times each fiscal year – the Executive Board follows, man- nally and externally in the year under review, in order to benefit ages and monitors Continental’s technology portfolio. from continually sharing knowledge. For example, we agreed a stra- tegic cooperation with , one of China’s largest internet compa- Below the Executive Board, the corporate technology officer (CTO) nies, for the further development of intelligent mobility. Continental is responsible for coordinating R&D activities, and is the central and Baidu will expand their technology exchange by each taking point of contact for strategic questions on future technology, inno- advantage of their respective benefits in automotive electronics vation and business opportunities. The CTO further strengthens and internet technologies, as well as forming a strong technological our technology leadership by ensuring, among other things, the alliance. Through the use of complementary resources and techno- ongoing planning of the medium- to long-term activities of the logical expertise, both partners aim to develop technologies, prod- technology strategy, technology scouting, technology reviews, ucts, and business models to provide comprehensive and reliable and the constant expansion of our research network. solutions for automated driving, connected cars and intelligent mobility services.

2017 2016 Research and development expenses (net) € millions % of sales € millions % of sales

Chassis & Safety 913.8 9.4 773.4 8.6 Powertrain 699.0 9.1 701.5 9.6 Interior 1,062.7 11.4 956.0 11.5 Tires 289.8 2.6 260.9 2.4 ContiTech 138.4 2.2 119.7 2.2

Continental Corporation 3,103.7 7.1 2,811.5 6.9

Capitalization of research and development expenses 92.1 105.9 in % of research and development expenses 2.9 3.6 Depreciation on research and development expenses 74.5 54.3

50 Continental AG 2017 Annual Report Management Report Corporate Profile

Under the agreement, Continental and Baidu will join together to BEE – for personal mobility in urban traffic focus on areas such as sensor technology and software for ad- We are using the CUbE (“Continental Urban mobility Experience”) vanced driver assistance systems and automated driving. In addi- test vehicle to investigate and test driverless passenger transporta- tion, they will work on applications for Baidu’s Apollo platform (plat- tion in . This kind of vehicle, also known as a driverless form for the development of automated vehicles) – including artifi- taxi, will play a crucial role as an addition to public transport in the cial intelligence and data security – as well as road tests, data acqui- future. sition, and analysis for automated driving. Since 2017, Continental has been represented on the Apollo platform’s board of directors We developed a visionary and trendsetting concept for personal by the Chassis & Safety division. We supply hardware and software mobility in 2017, which was presented at the International Motor components to create a platform that will enable safe autonomous Show (IAA) in Frankfurt. It is called BEE (“Balanced Economy and driving for everybody. Ecology mobility concept”) and is part of a comprehensive per- sonal mobility solution in urban spaces. BEE is an electric vehicle designed for stress-free, convenient and comfortable rides in cities. Artificial intelligence (AI) was one of the other core topics in R&D in The vehicle is intended for people of all ages and can adapt itself to the year under review. This is the term for a technological revolu- the passengers’ needs. You can call BEE to your location via an app. tion that will change the world in countless ways. AI has already Continental’s mobility concept envisages just a few minutes be- reached an important milestone thanks to more data, better algo- tween the online order and its arrival. BEE can also be used to effi- rithms and faster, more affordable computers. In the future, AI is ex- ciently transport small volumes of goods. It is also conceivable that pected to be used as universally as software is today. We are exam- many BEEs will one day form a swarm of autonomous vehicles of ining and testing the areas in which we can apply AI methods – in various sizes and models. the company and for our customers. AI will have a further influence in the automotive industry. We want to make personal mobility eas- The development of BEE was influenced by the experience and in- ier by creating new AI-compatible products and services, from au- ventiveness of our employees worldwide. They are familiar with the tomated driving systems to digital mobility assistants, from multi- challenges and requirements of future urban environments and transport travel planning to predictive maintenance. We use effi- know how they want to be mobile in the future. Our employees cient and effective algorithms for this purpose. Continental is work- contributed ideas as to what unconventional and original solutions ing closely with top universities and research institutes around the to upcoming transport and mobility needs might look like. world. At the same time, we are strengthening our in-house exper- tise to integrate these algorithms into our products, services and processes.

R&D expenses (net) € millions R&D ratio %

9.9% 10.1% 3,104 8.9% 2,812 2,676 2,450 6.9% 7.1% 2,431 6.2% 2,097

2.2% 2.4% 2.4%

352 381 428

2015 2016 2017 2015 2016 2017 2015 2016 2017

Rubber Group AutomotiveContinental Group Corporation Automotive Group Rubber Group Continental Corporation

Continental AG 2017 Annual Report Management Report Corporate Profile 51

Sustainability

Sustainable management and social In the year under review, the Executive Board launched a project to further ingrain sustainability in our organization and improve responsibility are at the heart of our values. our existing processes. With the participation of all pertinent de- partments and involving the managers of the various divisions, We consider sustainable management to be a strategic task for specific recommendations and measures were defined, which are corporate development. Our Roadmap 2020 defines the precise then to be implemented successively. These include the implemen- objectives for our four dimensions (corporate governance and cor- tation of a new strategy for our commitment to society. porate culture, employees and society, environment, and products). Employees and collaboration In evaluating our performance, we use financial and non-financial Respecting people, valuing their achievements and fostering their indicators and criteria. It is essential that sustainability goals and abilities are the foundations of our HR work. Continental is a diverse measures create value. After all, only then will they be accepted company whose employees come, for instance, from various ethnic, within the company and seen as credible by those outside. cultural, and religious backgrounds. We value and foster the diverse ideas and experiences of our employees. They are the key to our Our BASICS are the foundation of Continental’s success. These cor- success. By supporting them in the course of their professional de- porate guidelines outline our vision, mission and our values, which velopment and fostering their talents, we are creating added value in turn define our corporate activities and the way we interact with not only for our employees, but also for the company, our custom- one another and with all other stakeholders. They also underscore ers and other stakeholders. our careful use of resources, our social responsibility and our cul- ture of working for one another. The BASICS are our compass in In addition to training and development opportunities – not to men- this time of digital transformation because our working world is tion fair wages and salaries – we also offer our employees attractive changing profoundly. We believe this transformation presents con- social benefits. The health of our employees and job security are siderable opportunities for our company, for climate protection and top priorities as well. for road safety. Environmental and climate protection The interplay between our BASICS, our corporate governance Environmental protection is an integral part of our company policy. guidelines, and our comprehensive code of conduct, to which all For us, economics and environmental awareness are not contradic- employees of the corporation are bound, gives rise to a responsible tions, but are the foundation for sustainable value creation at Conti- approach to corporate governance and oversight that is aimed at nental. generating lasting added value. Our environmental management system is based on global mega- Responsible corporate management also requires dealing with trends, which also form the basis of the corporation’s overall strat- risks in a responsible manner. Continental has a corporation-wide egy. This system incorporates all levels of the value chain and the internal control and risk management system that is used to ana- entire life cycles of Continental products. As a result, our environ- lyze and manage the risks to the company. mental responsibilities extend from research and development, the purchasing of raw materials and components, logistics and produc- As a signatory of the United Nations Global Compact, we support tion, to the use and recycling of our products. Our service pro- its 10 principles in the areas of human rights, labor, the environ- cesses are geared toward continuously improving the use of re- ment and anti-corruption. sources in relation to business volume.

We outline the progress we are making on the sustainability front Social obligations and responsibility in our report prepared in line with the Global Reporting Initiative Compliance with all the legal requirements that apply to Continen-

(GRI) standard as well as online in our sustainability section at tal AG and its subsidiaries and adherence to internal regulations by www.continental-sustainability.com. all employees form part of our obligations and shape our corporate culture. In addition, we report for the Continental Corporation and Conti- nental AG in a separate non-financial statement pursuant to sec- Through profitability, we lay the foundations for safeguarding jobs tions 315b and 315c in conjunction with sections 289c to 289e in many regions of the world. We also aim to create value for the of the German Commercial Code (Handelsgesetzbuch – HGB). people who live and work near our locations. Our voluntary activi- This statement is published online in the Sustainability/Downloads ties focus on three areas in which we wish to position ourselves section of our website . based on our business model, our challenges, and how we view ourselves as a company; and where we aim to promote forward- looking development: social welfare and road safety, education and science, as well as sports.

52 Continental AG 2017 Annual Report Management Report Corporate Profile

Employees › “Enable Transformation” supports digital transformation at Conti- nental so that we can make the most of the opportunities of digi- talization throughout the corporation. Our people, our culture, our future – employees and corporate cul- ture guarantee the success of our company. “Industrialize Best Fit” – meeting staffing needs with precision In the year under review, we received nearly 400,000 applications Personnel work is an important part of our company’s value crea- for salaried positions worldwide – with about 73,500 in Germany tion and plays a key and pioneering role in our growth strategy. alone – which demonstrates that Continental is a highly attractive Our employees and the way we work together are key to our future employer for people all around the globe. At the same time, this success. They drive our technological progress and growth and lay large number presents the personnel systems and processes with the foundations today for the success of our company tomorrow. particular challenges, since it is important to know our require- ments and find the right applicant for the right position as effi- We value our employees whose skills, abilities and achievements ciently as possible. are our company’s most valuable asset. Our goal is to make optimal use of their skills and develop them in the best-possible way. Our We are working on a number of closely related projects in the con- Human Relations (HR) team actively supports our employees in text of improving our HR data and systems, HR planning and re- their professions and careers and encourages them to develop cruitment, and employee development. In the medium term, what their talents. We thereby create tangible value: for our employees, we are looking for at Continental is not somebody for a job, but our company, our customers and all other stakeholders. rather the right position at the company for a particular candidate. What counts is the person who is the best fit for a vacant position. Employees by region This means the person with exactly the right skills, abilities and val- ues for the job and for Continental. The better the fit between em- Europe excluding ployees and their jobs at Continental, the more satisfied and moti- Germany Germany (PY: 26%) 26% vated the employees will be, which are key factors for productivity 32% (PY: 32%) and quality. This best fit is becoming increasingly important in light of the growing need for suitable employees.

Strategic HR planning In view of future growth and increasingly short innovation cycles, Other regions Asia 4% (PY: 4%) we need to act now to identify and secure future personnel require- (PY: 19%) 19% North America ments. This is why the HR teams around the world are involved in 19% (PY: 19%) the product development process at an early stage, in close collab- oration with the business units.

We rely on strategic HR planning that further increases the level of Our HR policy is holistic and based on working with and for one detail in our plans while also creating a uniform and reliable cross- another. In our collaboration, we attach great importance to rela- divisional HR strategy. In this context, we simulate firstly the ex- tionships with one another and to ensuring that the shared corpo- pected development of our current workforce based on factors rate values – Trust, Passion To Win, Freedom To Act and For One such as retirements and staff turnover and, secondly, the personnel Another – are put into practice. These values are the basis of our requirements that we need in order to successfully achieve our corporate culture and shape the way we interact with each other business goals. By comparing these two factors, we can identify the and with our customers and partners. Continuous development of quantitative and qualitative requirements at an early stage so that our corporate culture is therefore a vital part of ensuring our future we can build up the required expertise in good time. The results viability and creating value. help us, for example, to identify how the challenges of digital trans- formation will affect the requirements for individual employees, so Our HR policy is founded on two strategic pillars within which we that corresponding training measures can be initiated on a prepara- implement different HR projects and initiatives. Based on these two tory basis in the next step. pillars, we systematically develop our HR work further and make it fit for the future. After establishing a binding framework for requirements planning with uniform processes and principles in a pilot project in 2016, › With “Industrialize Best Fit,” we are developing HR management we implemented strategic HR planning throughout the corporation in the context of our “best fit” concept in order to meet our con- in the reporting year. For example, 98.5% of all employees in our siderable need for employees with the right skills and abilities – global HR system were covered by the strategic HR planning. now and in the future.

Continental AG 2017 Annual Report Management Report Corporate Profile 53

Structure of the workforce Dec. 31, 2017 Dec. 31, 2016 Total number of employees 235,473 220,137 thereof permanent staff 219,687 206,162 outside Germany 162,833 152,136 in Germany 56,854 54,026 Trainees1 2,155 2,067 Female employees in % 27.2 27.0 Average years of service to the company1 14.3 14.6 Average age of employees in years1 43.2 43.3

1 In Germany.

Big-data analyses in HR Training record in the reporting year In the year under review, we expanded our approach to strategic HR In fall 2017, 702 trainees in Germany began their training, dual planning to additional locations with big-data-assisted skill analyses – studies or an entry qualification at Continental – the largest ever i.e. determining skills and expertise through the evaluation of data. training cohort in our history. We have more than tripled the num- This global, strategic skills management approach now covers 35% ber of traineeships we offer over the last 20 years. of all IT employees as well as software and electrical engineers. Around 1,000 highly specialized skills from the most varied of soft- In 2017, it was not only the numbers that increased but also the ware fields and their distribution among the employees have been quality. At 10.3%, the ratio of outstanding performance (final identified in the process. This has made it possible to determine tar- grade of “very good”) in our training placements is higher than geted, forward-looking HR measures, including measures for qualifi- the German average measured by the Chamber of Industry and cation, recruitment and intensifying cooperation with universities. Commerce (6.6%). In addition, we have taken the first steps toward establishing inter- nal big-data skills within the HR environment in order to turn the Training program for automotive software technicians existing data to our advantage more efficiently. As part of our best-fit initiative, we also continue to give practically minded individuals and career changers the opportunity to devel- Diagnostic procedure to find the right employee op “from career changers to career climbers” – especially if they To further improve the best fit between applicants and vacant posi- have specific skills in software and technology. For example, in tions and thus enhance the quality of our recruitment processes, 2017, Continental expanded its training and education program we have developed and intensified various diagnostic projects in for software experts to include an additional module. The advanced 2017. qualification for automotive software technicians offers our employ- ees a three-year course ending in an officially recognized qualifica- One of them is being carried out at our location in San Luis Potosí, tion. In the selection process, we do not mainly rely on formal edu- . The locations in Makó, Hungary, and Chongqing, China, cational qualifications but trust in skills and abilities. A good soft- were new additions. Here, extensive online and on-site tests and ware developer or technician does not necessarily need a degree. work samples were used to select employees for our factories. The We want to use our education and training program to counter the unique feature of this process is that candidates for wage-earning general shortage of skilled IT staff early on. Our tailor-made educa- roles do not apply for specific positions, but rather are given recom- tion formats make us less dependent on the job market and there- mendations as to which positions represent the best fits for them. fore more competitive. The overriding objective of these pilot projects is to establish a global, standardized selection process for wage-earning employees.

For salaried positions, we have introduced scientifically validated and standardized online processes, which we want to use to gain an impression of the applicant’s skills at an early stage of the appli- cation. The international rollout of the Continental online assess- ments for salaried positions is close at hand.

In addition, we have begun to update the potential diagnostics landscape for the various management levels at the corporation.

54 Continental AG 2017 Annual Report Management Report Corporate Profile

“Enable Transformation” – accompanying digital opment, strengthen their impact and increase their presence within transformation the corporation. Similar national events in Korea and with the Digital transformation is presenting major challenges for Continen- same aim reached another 240 participants. tal, too. After all, the digitalization of the working world is changing established and familiar structures. Product cycles are becoming “Experiencing diversity as a catalyst and requirement for innova- shorter, which means companies need to be able to flexibly adapt tion” – this was the theme of the second and third Diversity Sum- to new customer requirements and rapidly develop new business mits in Berlin, Germany, and Hangzhou, China. Both events brought models. an international group of attendees together to experience the benefits of diversity and to generate creative ideas for the further At the same time, digitalization offers our company many opportu- development of the Continental culture. The group of “transform- nities – both in terms of tapping new markets and also with regard ation champions” continues to meet up online once a month to to training our employees. For this reason, the Human Relations push forward the changes planned together. team is actively helping shape digital transformation. Competitive advantages emerge if the company and its workforce adapt to the Promotion of entrepreneurial spirit with comprehensive startup new conditions more quickly and flexibly than others. That is why program we must be more agile, innovative and interconnected in the way A startup program was launched in 2017, the first part of which we think and act. In this context, we are promoting four key areas: was “incubator,” which gave our employees the opportunity to im- plement their own business ideas in a startup environment as new › Diversity management – essential requirement for creative ideas entrepreneurs. The aim is to foster talented entrepreneurs, increase and alternative solution strategies. agility, accelerate cultural transformation into the new working world, and develop pioneering concepts that will drive Continental’s › Flexible working conditions – enable our employees to maintain a long-term success. healthy work-life balance. More than 32,000 employees from 10 pilot locations in seven › Inspiring leadership culture – increases the enjoyment derived countries took part in a company-wide competition. 420 concepts from commitment and spurs people on to perform well. were submitted. The three winning teams were given the chance to develop their concepts further in a startup environment away from › Lifelong learning and intensive exchange of knowledge between their normal jobs for three months. our employees – give rise to the best solutions for our customers. Flexible working conditions come into force In 2017, we focused on enhancing our diversity management, flex- After we defined the global framework for flexible working condi- ible working conditions and our leadership culture. tions at the end of 2016, 2017 was characterized by the global im- plementation of the measures. In 18 countries, our employees can Equal opportunities and increasing diversity now configure their ways of working more individually, and we are Equal opportunities and diversity – we attach particular importance on the homestretch in three more countries. Employees through- to these issues in our selection procedures and talent develop- out the entire corporation from all hierarchical levels are now mak- ment. After all, it is our employees’ diverse perspectives, character- ing the most of opportunities for mobile working, part-time and istics, experience and cultures that help make our company innova- flextime working, and sabbaticals. tive. Our activities are currently focused on internationality and a balanced gender ratio. Today, 45% of our management team does We are currently working on various options for our employees in not come from Germany. The percentage of women at manage- the production units. The challenge is to square the demand for ment level worldwide has also increased again – from 12.2% in flexible models with the requirements of a highly efficient produc- 2016 to 13.4% in 2017. We aim to staff 16% of all management tion environment, for example, through autonomous methods for positions with women by 2020. For more information about our shift planning, time-out models (“mini-sabbaticals”) or attractive targets for the percentage of women in management positions, part-time models. please see the Corporate Governance Declaration in the Corporate Governance Report on page 22. Mastering digital transformation through a good leadership culture Diversity breeds innovation Digitalization and globalization are radically changing and acceler- In 2017, we held additional events to promote diversity besides the ating the working world. More is also being demanded of manage- more than 25 Diversity Days around the world. ment than ever before. Managers are having to organize the old and the new in equal measure. In order to master this challenge In the reporting year, the second Women@Work event was held while further elevating the quality of all processes and products, we with 75 participants, mostly from Europe and South Africa. The aim focused on our leadership culture in 2017, launching a wide-ranging of this event was to support young women with their career devel- internal dialogue both with employees as well as with managers.

Continental AG 2017 Annual Report Management Report Corporate Profile 55

The result is the modernization of our management philosophy. Geared toward this management approach, we are supporting Continental is tackling the changes with an approach that unites management quality at Continental with a combination of ongoing two fields of modern management while at the same time fostering measures. To increase the globally consistent quality of the leader- quality. The first element, “values-based leadership,” prioritizes man- ship architecture development programs offered, a quality manage- agers’ role model function, their actions according to clear values ment system was prepared and introduced in 2017 and is ex- and the use of new methods of working. The second element, pected to result in DIN ISO certification in 2018. “transformational leadership,” promotes the role of the manager as an active and inspiring driver of the transformation of the market, corporation and employees.

56 Continental AG 2017 Annual Report Management Report Corporate Profile

Environment the environmental targets there, too. In waste generation and recy- cling, it also appears that the achievement of the targets will require further initiatives besides the programs to reduce waste and in- About 25 years ago, Continental introduced a corporate-wide envi- crease the recycling rate already begun. ronmental management system and extended the corporate strat- egy to include ecological targets and measures. In the early years, CO2 emissions the focus lay on conserving finite resources together with reducing harmful emissions and the company’s environmental footprint. To- day, the scope of our environmental management system goes far 738 754 730 beyond these objectives. Sustainable management at all stages of 662 677 640 613 the value chain and throughout the entire life cycles of our prod- ucts is now an integral part of our philosophy. We are gradually ful- filling this responsibility more widely in the supply chain in order to further anchor our strategic alignment as a sustainable company.

The environmental strategy for 2020 makes up the framework of our environmental management policy and outlines a number of clear objectives, indicators and measures. We are working on up- dating our environmental strategy for the time up to 2030, aligning 2015 2016 2017 Target 2020 ourselves with the United Nations’ 17 sustainable development

SpecificSpecific CO2 emissions CO2 emissions for plants (100 included kg/€ million in 2013 in adjusted sales) for all plants goals (SDG). Specific CO2 emissions (100 kg/€ million in adjusted sales) for all plants (including(including acquisitions acquisitions and new and constructions) new constructions) Specific CO emissions for plants included in 2013 Environmental strategy pays off ecologically and 2 economically By committing ourselves to extensive sustainability goals, we are Certification to environmental standard ISO 14001 is to be compul- not only acting responsibly toward the environment and society – sory for our strategic suppliers as well. Under these circumstances, we are also thinking and acting in a forward-looking manner and in we have defined an extensive catalog of individual measures that the interests of creating value for our company. We see the chal- all serve the same goal of continuously improving our environmen- lenges that lie ahead – such as climate change, globalization and tal performance. urbanization – as opportunities. These opportunities not only re- quire our innovative prowess and the development of innovative As in previous years, all environmental performance figures were technologies and more efficient products, they also boost our com- audited as part of an independent limited assurance audit by audit- petitiveness. ing firm KPMG AG Wirtschaftsprüfungsgesellschaft.

In the reporting year, Continental generated around 40% of consoli- Sharper focus on the protection of drinking water dated sales through products that are exceptionally energy efficient Around 41% of the world’s population is currently living in regions and/or reduce CO2 emissions. Our environmental strategy and the that experience (in some cases extreme) water shortages, while achievement of our environmental targets pay off ecologically and economically. Water consumption

Clear targets for improvement 480 We have set ourselves clear targets. By 2020, we want to reduce 442 456 422 414 our CO2 emissions, energy and water consumption, and waste gen- 396 394 eration by 20% – in relation to adjusted sales, using 2013 as a ba- sis. We also intend to improve our waste recycling and reuse rate by two percentage points a year. We are on track to achieve our targets. With regard to energy consumption, CO2 emissions and water consumption, we already achieved a reduction of roughly 13% to 15% three years before the end of the timeframe at the lo- cations where we launched the environmental strategy programs in 2013. However, it is also apparent that the consolidated key fig- ures for the environment have not developed in the desired direc- 2015 2016 2017 Target 2020 tion due to the many acquisitions in recent years. The number of 3 sites that must be included in reporting has increased from 191 in SpecificSpecific water consumptionwater consumption (mfor3 all/€ plants million(m /€ included millionin adjusted in in adjusted 2013 sales) forsales) all plants for all plants (including acquisitions and new constructions) 2013 to 245 in 2017. Further measures must be implemented at (including acquisitions and new constructions) Specific water consumption for all plants included in 2013 our new locations so that we can contribute to the achievement of

Continental AG 2017 Annual Report Management Report Corporate Profile 57

800 million people have no access to clean drinking water. In many Reduction of plastic waste countries, untreated wastewater is still finding its way into the water Plastic waste is becoming an increasingly serious global environ- cycle. These and other problems will continue to intensify as a re- mental problem. To raise awareness of this issue among all employ- sult of climate change, and at the latest then, there will be an eco- ees and decision makers, the Executive Board has initiated a proj- nomic impact – even for local companies. To prepare ourselves to ect to significantly reduce plastic waste at Continental. There are tackle future risks, while at the same time making a contribution to three strands to this initiative: sustainable development, we have placed the issue of water higher on our environmental strategy agenda. In the reporting year, we › Banning plastic tableware and cutlery from our cafeterias world- launched a program that includes a detailed water risk analysis as wide. well as the evaluation of our own locations together with the as- sessment of the supply chain and its effects on water consumption. › Improving waste management and rates of plastic-waste recy- Measures derived from this are planned for 2018. cling.

Energy consumption › Reducing packaging waste and significantly increasing the amount of reusable packaging in the logistics and purchasing 819 process. 777 784 735 718 701 669 These measures are being tested and analyzed at 10 selected pilot locations. All best-practice measures will then be incrementally rolled out worldwide.

Waste generation and recycling

88 88 90 82 83 82 81 81 77 79 2015 2016 2017 Target 2020 68

SpecificSpecific energy energy consumption consumption for(GJ/ plants€ million (GJ/ included€ millionin adjusted in in 2013 adjusted sales) forsales) all plants for all plants (including(including acquisitions acquisitions and new and constructions) new constructions) Specific energy consumption for plants included in 2013

Successful project for sustainability in the supply chain Sustainable and resource-efficient management is a key compo- nent of our environmental strategy. This also applies to our supply 2015 2016 2017 Targets 2020 chain. A project begun in 2015 to improve the environmental per- formance of our suppliers in the Mexican states of Jalisco and Gua- Waste Specificrecycling waste (%) generation (100 kg/€ million in adjusted sales) for all plants Specific(including waste generation acquisitions (100for andplants kg/ new€ includedmillion constructions) in in adjusted 2013 sales) for all plants najuato was successfully completed in the reporting year. The aim (including acquisitions and new constructions) Specific waste generation for plants included in 2013 of the initiative was to train and help the suppliers to establish and Waste recycling (%) enhance their own environmental and energy management sys- tems. The suppliers that received training as part of the project have achieved excellent success together with the Continental lo- cations in Mexico and made a positive contribution to environmen- tal protection. In total, approximately:

› 775 tons of CO2 emissions › 923 megawatt hours of energy › 210 tons of waste › 4,600 cubic meters of water were saved in the two-year project. Due to the successful imple- mentation of the measures and the good networking between the suppliers, we have decided to continue this project and to open it up to additional suppliers.

Further information is available from the website set up for the project: www.sustainabilitynetwork.net.

58 Continental AG 2017 Annual Report Management Report Corporate Profile

Social Responsibility In Thailand, many young people drive and are therefore exposed to the hazards of the road. Road safety is a particular concern for Conti- nental. For four years, Continental employees have therefore been Operating globally also entails taking on social responsibility on a providing safety training for young drivers in cooperation with the global level. By being committed to social responsibility, we are Rayong highway police. Selected employees and members of the making a positive contribution to society while also creating value Thai highway police put on workshops to give students detailed in- for our company. Our activities focus on social welfare, road safety, formation on what to look out for on the road. For example, how to education, science and sports. The following are a few examples. protect themselves and others from hazards, what distinguishes a safe vehicle and the importance of wearing a helmet on mopeds We take on social responsibility mostly on a decentralized basis. and motorcycles. Charitable projects, activities and donations are often initiated and organized by dedicated employees and supported by the com- Creating opportunities for refugees pany. Integrating people of different origins and cultural backgrounds is an important part of our corporate culture. For over a year, we have In particular emergency situations, Continental provides central been working with the German Federal Employment Agency on a support with national projects and challenges, or offers assistance new, specially developed program that makes it easier for refugees in dealing with international humanitarian emergencies. In doing to enter the job market. In this program, Continental offers refugees so, the corporation as a whole fulfills its social responsibility. a work placement of up to 12 months.

Support in international disasters This allows the participants – while receiving the standard remuner- In September 2017, we supported the disaster relief in Texas, U.S.A., ation for the first year of an apprenticeship – to obtain the qualifica- after the historic flooding caused by Hurricane Harvey. The dona- tion needed for an apprenticeship. Once completed, they have the tion, which went to the American Red Cross, consisted of an amount chance to begin a company apprenticeship at Continental. donated directly by Continental and an amount matching dona- tions from employees. In addition to the company’s financial assis- Supporting young jobseekers and inspiring love for Europe tance, the employees at local sites became actively involved in the Under the umbrella of the “Experiencing Europe” initiative, Conti- relief effort in Houston and other areas of southern Texas. nental has launched a program especially for young people. To- gether with the German Federal Employment Agency, we offer In October 2017, we supported the disaster relief in the areas of jobseekers aged between 18 and 25 short internships at company Mexico affected by the earthquake. In addition, we called on our locations throughout the rest of Europe. The program is open to employees in North America to donate money to the earthquake young adults with no professional experience or qualifications. The victims and we doubled the donated amount. In order to help the project is an initiative throughout all of Germany. earthquake victims directly, our team in Mexico collected donations of food, household items and other necessities. The aim is to help young people access the rest of Europe and thus strengthen the spirit of European community. We also see the Local involvement project as an opportunity to discover potential employees and tal- Continental supports charitable initiatives with financial donations ented young people. both large and small, with donations of goods, and with active in- volvement. In this context, our employees show their strong social The pilot project for the initiative was launched at Continental in commitment as good neighbors locally. June 2017. Under the name “We l.o.v.e. Europe,” the first participants started foreign internships at Continental locations in Belgium, Continental’s employees in Stöcken, Hanover, donated all the pro- France, Hungary, Italy, Portugal, Romania and the United Kingdom. ceeds from their summer festival to an organization that takes care In the meantime, further companies have joined the “Experiencing of children with burn injuries and their families. The initiative offers Europe” initiative to give even more young adults the opportunity advice to affected families after burning and scalding accidents in- to gather professional experience in Europe. volving babies and children. Its main activities include advice and providing contacts during the hospital stay, assistance during reha- bilitation and afterwards, and preventive measures.

Continental AG 2017 Annual Report Management Report Economic Report 59

Economic Report General Conditions

Macroeconomic Development The Japanese economy recovered in the year under review, thanks especially to the sharp increase in the foreign trade surplus due to the weakening of the Japanese yen against the euro and other cur- In Germany, the solid economic growth of recent years accelerated rencies. Private investment and consumer spending also increased, in 2017. According to initial calculations by the German Federal while government spending virtually stagnated. Based on the IMF’s Statistical Office, gross domestic product (GDP) increased by 2.2% current expectations, the Japanese economy may have grown 1.8% year-on-year when adjusted for prices in the year under review, af- year-on-year in 2017, partly due to the continuing expansionary ter 1.7% in 2015 and 1.9% in 2016. This clearly surpassed the fore- monetary policy of its central bank. The growth was therefore much cast of 1.5% formulated by the International Monetary Fund (IMF) stronger than the 0.8% forecast by the IMF at the start of the year. in January 2017. The significant growth was due in particular to higher private investment, but also consumer and public spending. According to the IMF’s WEO Update (World Economic Outlook, WEO) from January 2018, emerging and developing economies In addition to Germany, the other countries of the eurozone also achieved growth totaling 4.7% in 2017 (PY: 4.4%). In January 2017, saw a continuing economic upturn in 2017 for the most part thanks the IMF had initially forecast 4.5%. China and India were the main to higher capital expenditure by companies and increased con- growth drivers once again. With a reported increase in GDP of sumer and public spending. According to the latest figures from the 6.9%, the Chinese economy performed better than the IMF’s fore- statistical agency Eurostat, the eurozone economy achieved GDP cast of 6.5% at the start of 2017. By contrast, the IMF reports that growth of 2.5% in the year under review and likewise surpassed the India’s GDP grew by 6.7%, falling short of its forecast of 7.2% be- IMF forecast of 1.6% from January 2017. Economic development cause the radical reform of the VAT system had a dampening effect was boosted further by the monetary policy of the European Cen- on the economy. Russia and Brazil also performed better in the re- tral Bank (ECB), which continued to adhere to its expansionary porting year than expected in January 2017, benefiting from the measures in 2017. recovery of the raw-materials sector.

The U.S. economy picked up momentum from quarter to quarter The IMF’s January 2018 WEO Update indicates that the global during 2017 and is expected to have achieved GDP growth of economy grew by 3.7% after 3.2% in the previous year. The IMF’s 2.3%, meeting the IMF’s forecast from January 2017 precisely. This January 2017 forecast of 3.4% growth was surpassed as a result was due primarily to an increase in consumer spending and private of the stronger economic performance in the eurozone as well as investment. In March, June and December 2017, the U.S. Federal in Japan and China. Reserve (Fed) increased its key interest rate by 25 basis points each time. With a most recent target of between 1.25% and 1.5%, its key interest rate nevertheless remained low.

Sources: IMF – World Economic Outlook Update January 2018, Eurostat, statistical offices of the respective countries, Bloomberg.

60 Continental AG 2017 Annual Report Management Report Economic Report

Development of Key Customer Sectors After demand in China was curbed in the first half of 2017 by the increase in sales tax from 5% to 7.5% on passenger cars with a cu- bic capacity of less than 1.6 liters, sales volumes picked up again in The most important market segment for Continental is the global the third quarter. However, the previous year’s record of 7.5 million supply business with the manufacturers of passenger cars and units was not quite reached in the fourth quarter. According to the commercial vehicles, accounting for 72% of sales in fiscal 2017 VDA, new passenger- registrations in China rose by 2% to 24.2 (PY: 73%). The second-biggest market segment for Continental is million units in total in 2017. In the other BRIC countries, demand global replacement-tire business for passenger cars and commer- grew faster as a result of the improving economic situation. Sales cial vehicles. Because passenger cars and light commercial vehicles volumes increased by 12% in Russia and by 9% in both India and weighing less than 6 metric tons make up a considerably higher Brazil. share of vehicle production and replacement-tire business, their development is particularly important to our economic success. The growth in sales volumes in Europe, Asia and South America more than offset the decline in demand in the U.S.A. in the year Continental’s biggest sales region is still Europe, which accounted under review. According to preliminary data, new passenger-car for 49% of sales in the year under review (PY: 50%), followed by registrations worldwide increased by over 2% to 93.3 million units North America with 25% (PY: 26%) and Asia with 22% (PY: 21%). in 2017.

Development of new passenger-car registrations Development of production of passenger cars and Demand for passenger cars in Europe (EU-28 and EFTA) continued light commercial vehicles to rise in 2017. On the basis of preliminary data from the German Preliminary data indicates that production of passenger cars and Association of the Automotive Industry (Verband der Automobil- light commercial vehicles weighing less than 6 metric tons in industrie, VDA), new passenger-car registrations increased by 3% Europe increased by 3% in 2017. Production rose significantly in year-on-year to 15.6 million units. In addition to the ongoing eco- Russia, Turkey and France in particular, while production in Germany, nomic upturn and low interest rates, this was attributable to rela- Spain and the United Kingdom fell slightly short of the respective tively high demand for replacements, particularly in Southern and high figures of the previous year. The lower number of working Eastern European countries. Among the major markets, Italy and days had a significant influence in Germany, while falling demand Spain again posted the highest growth rates, both with 8%. Demand was the central cause in the United Kingdom. for passenger cars rose by 5% in France and by 3% in Germany. In contrast, the United Kingdom saw a 6% decline in demand. In North America, the production of passenger cars and light com- mercial vehicles decreased by 4% on the basis of preliminary fig- In the U.S.A., the number of new car registrations fell by 2% to 17.1 ures. The production of passenger cars declined considerably due million units in 2017, but remained at a high level. The reduction to the lower demand. In contrast, the production of pickup trucks in was due to a 12% decline in demand for passenger cars. In con- particular increased as a result of demand. The production of pas- trast, demand for light commercial vehicles, especially pickup trucks, senger cars and light commercial vehicles fell by more than 8% in rose by 4% year-on-year due to low fuel prices and favorable lend- both the U.S.A. and Canada. This decline was only partly offset by a ing rates. sharp rise in production in Mexico.

In Japan, the improved economic situation and increased consumer In Asia, production of passenger cars and light commercial vehicles confidence resulted in higher demand for passenger cars in 2017. increased in most countries in 2017. Japan, India and Iran saw high New car registrations rose by 6% to 4.4 million units. volume growth as a result of demand. Production also still increased

New registrations/sales of passenger cars millions of units 1st Quarter 2nd Quarter 3rd Quarter 4th Quarter 2017 Total ∆ Prior Year

Europe (EU–28 and EFTA) 4.3 4.2 3.6 3.6 15.6 3% U.S.A. 4.0 4.4 4.4 4.3 17.1 –2% Japan 1.3 1.0 1.1 1.0 4.4 6% Brazil 0.5 0.5 0.6 0.6 2.2 9% Russia 0.3 0.4 0.4 0.5 1.6 12% India 0.8 0.7 0.9 0.8 3.2 9% China 5.8 5.2 5.8 7.4 24.2 2% Worldwide 23.0 22.8 22.7 24.8 93.3 2%

Sources: VDA (countries/regions) and (worldwide).

Continental AG 2017 Annual Report Management Report Economic Report 61

Production of passenger cars and light commercial vehicles millions of units 2017 2016 2015 2014 2013 Europe1 22.1 21.4 20.8 19.9 19.2 North America 17.1 17.8 17.5 17.0 16.2 South America 3.3 2.7 3.1 3.8 4.5 Asia2 51.5 50.0 46.4 45.8 44.0 Other markets 1.1 1.1 1.0 0.9 0.8

Worldwide 95.1 93.1 88.8 87.4 84.7

Source: IHS Inc., preliminary figures and own estimates. 1 Western, Central and Eastern Europe, including Russia and Turkey. 2 Asia including Kazakhstan, Uzbekistan, Middle East and Oceania with Australia. sharply in China in the first quarter, but the momentum slowed pal- duction of commercial vehicles weighing more than 6 metric tons pably over the rest of the year. Nevertheless, the growth of around in Europe increased 9% year-on-year in 2017. 570,000 units was the largest volume growth of all Asian countries. Due to the high comparative basis of 27.1 million units, however, After the slump in the previous year, commercial-vehicle produc- this equated to an increase of only 2%. South Korea, Australia and tion in North America stabilized during the first half of 2017. The Malaysia posted declining production data. Preliminary data shows increasing economic momentum over the course of the year re- that production in Asia as a whole grew by 3% year-on-year in sulted in growing demand for trucks and a revival of truck produc- 2017. tion in the second half of the year. According to preliminary data, production increased by 8% in 2017 as a whole. In South America, the recovery of demand led to an increase in pro- duction of passenger cars and light commercial vehicles. According The production of medium and heavy commercial vehicles in- to preliminary data, production volume grew by around 550,000 creased sharply in Asia, especially China, and reached record vol- units in the year under review compared to the weak prior-year umes. By contrast, production in Japan was again down on the pre- figure. vious year’s level. India also just failed to reach the production vol- ume of the previous year. Preliminary data shows that commercial- On the basis of preliminary data, global production of passenger vehicle production in Asia grew by around 13% overall in 2017. cars and light commercial vehicles grew by 2% to 95.1 million units in 2017. In South America, the economic recovery led to rising demand for trucks and an increase of around 20% in the production of medium Development of production of medium and and heavy commercial vehicles over the course of the year, accord- heavy commercial vehicles ing to preliminary data. Despite the significant volume growth, pro- In Europe, the improved economic situation in 2017 caused a rise duction in 2017 was still far below the production level of the pre- in the transportation of goods by road and an increase in demand crisis years 2013 and 2014. for trucks. Truck production was consequently stepped up in al- most all countries, with Russia, Germany and Turkey posting the As a result of the production increase in all regions, preliminary largest volume growth in the production of medium and heavy data indicate that global production of medium and heavy com- commercial vehicles. Overall, preliminary data shows that the pro- mercial vehicles rose by 12% in the year under review.

Production of medium and heavy commercial vehicles thousands of units 2017 2016 2015 2014 2013 Europe1 660 606 609 568 634 North America 513 475 581 550 470 South America 102 85 106 184 246 Asia2 2,140 1,894 1,636 1,843 1,845 Other markets 0 0 0 0 0

Worldwide 3,415 3,059 2,931 3,146 3,196

Source: IHS Inc., preliminary figures and own estimates. 1 Western, Central and Eastern Europe, including Russia and Turkey. 2 Asia including Kazakhstan, Uzbekistan, Middle East and Oceania with Australia.

62 Continental AG 2017 Annual Report Management Report Economic Report

Sales of replacement tires for passenger cars and light commercial vehicles millions of units 2017 2016 2015 2014 2013 Europe 351 340 328 324 313 North America 285 285 278 277 264 South America 73 66 65 64 63 Asia 453 431 409 397 376 Other markets 47 45 43 41 39

Worldwide 1,208 1,168 1,123 1,103 1,056

Source: LMC International Ltd., preliminary figures and own estimates.

Development of replacement-tire markets for passenger cars Development of replacement-tire markets for medium and and light commercial vehicles heavy commercial vehicles In Europe – Continental’s most important market for replacement According to preliminary data, demand for replacement tires for tires for passenger cars and light commercial vehicles weighing medium and heavy commercial vehicles in Europe increased by less than 6 metric tons – sales volumes of replacement tires for 4% in 2017. Russia, other countries of Eastern Europe, and France passenger cars and light commercial vehicles rose by 3% year-on- saw particularly high volume growth. The price increases announced year in 2017 according to preliminary data. During the year, price by various manufacturers also resulted in purchases being brought increases announced for the second quarter of 2017 by many forward in the first quarter and thus in skewed demand volumes manufacturers, due to the rise in the costs of raw materials, caused during the course of the year. purchases to be brought forward to the first quarter of 2017. This accordingly led to lower volumes in the second and third quarters, According to preliminary data, demand for replacement tires for before sales volumes recovered again in the fourth quarter. medium and heavy commercial vehicles in North America, our other core market for replacement commercial-vehicle tires along- Sales volumes of replacement tires for passenger cars and light side Europe, increased by 4% year-on-year. Here, too, the price in- commercial vehicles also increased in North America in the first creases announced by various manufacturers caused sharp fluctu- quarter of 2017 due to purchases brought forward. As a result, ations in demand during the course of the year. there was only very modest demand in the following quarters. Ac- cording to preliminary figures, tire sales volumes in North America In Asia, sales volumes of replacement tires for medium and heavy in 2017 as a whole stagnated at the high level of the previous year. commercial vehicles grew by 3% in 2017 according to preliminary figures. Demand mainly followed the economic development of the Asia posted a further increase in demand for replacement tires for individual countries. China, Japan and India posted the highest passenger cars and light commercial vehicles in 2017. In China, nominal growth. Japan and India, the growing economy also resulted in higher sales volumes of replacement tires. Preliminary data shows that sales vol- In South America, the economic upturn again resulted in increasing umes in Asia as a whole grew by 5% in the year under review. demand for replacement tires for commercial vehicles in the year under review. According to preliminary figures, the sales volumes in In South America, preliminary figures show that stabilization of the the year as whole increased by 14% year-on-year. economy in 2017 led to an increase in demand for replacement tires for passenger cars and light commercial vehicles of about 11%. There was a 4% increase in global demand for replacement tires for medium and heavy commercial vehicles in 2017. Based on preliminary data, global sales volumes of replacement tires for passenger cars and light commercial vehicles grew by 3% in 2017.

Sales of replacement tires for medium and heavy commercial vehicles millions of units 2017 2016 2015 2014 2013 Europe 25.3 24.4 22.9 23.4 22.7 North America 24.5 23.6 22.8 22.0 20.0 South America 15.7 13.7 13.5 14.0 13.7 Asia 89.2 86.6 83.5 85.3 83.9 Other markets 7.8 7.5 7.2 6.9 6.3

Worldwide 162.5 155.8 149.8 151.7 146.6

Source: LMC International Ltd., preliminary figures and own estimates.

Continental AG 2017 Annual Report Management Report Economic Report 63

Development of Raw Materials Markets relatively limited at 6%. Overall, average prices for stainless steel in Europe increased by around 15% year-on-year in 2017.

Various raw materials such as steel, aluminum, copper, precious Aluminum is used by Continental primarily for die-cast parts and metals and plastics are key input materials for a wide range of dif- stamped and bent components, while copper is used in particular ferent electronic, electromechanical and mechanical components. for electric motors and mechatronic components. The price of alu- We need these components, in turn, in order to manufacture our minum rose sharply in 2017, with the annual average increasing by products and systems for the automotive industry. Consequently, 23% on a U.S. dollar basis and 20% on a euro basis year-on-year. developments in the prices of raw materials usually influence Conti- The price of copper also rose palpably in the second half of 2017, nental’s production costs indirectly, in most cases, via changes in with the annual average increasing by 27% on a U.S. dollar basis costs at our suppliers. Depending on the contractual arrangement, and 24% on a euro basis. these cost changes are either passed on to us after a certain amount of time or redefined in upcoming contract negotiations. Copper and aluminum indexed to January 1, 2013

In the reporting year, global economic growth resulted in increas- 125 ing demand for raw materials. After the sharp rise in the prices of many raw materials in the fourth quarter of 2016, prices initially 100 consolidated year-on-year before mostly increasing palpably again in the second half of 2017, especially among metals. 75 Carbon steel and stainless steel are input materials for many of the mechanical components such as stamped, turned, drawn and die- 50 cast parts integrated by Continental into its products. Average prices for carbon steel increased in Europe by around 30% com- pared to the previous year’s average. This was due firstly to the 25 growing demand for steel and secondly to the development of 2013 2014 2015 2016 2017 global market prices for the primary products iron ore and coking Aluminum Copper Aluminum coal. Although these abated again after the sharp rise at the begin- Copper ning of the year and in the fourth quarter of the previous year, they Source: Rolling three-month contracts from the London Metal Exchange (U.S. $ per stabilized at a much higher level than their respective averages in metric ton). the previous year.

Steel indexed to January 1, 2013 We and our suppliers use precious metals such as gold, silver, plati- num and palladium to coat a wide range of components. Prices

150 for gold, silver and platinum in 2017 remained at the average level of the previous year on a U.S. dollar basis, while they got slightly cheaper on a euro basis due to the appreciation of the euro over 125 the course of the year. In contrast, the continued rise in demand for palladium, which is used primarily for catalytic converters, caused a rapid price increase. The average price per troy ounce for the year 100 increased by 42% year-on year on a U.S. dollar basis, by 38% on a euro basis.

75 Both we and our suppliers require various plastic granulates, known as resins, as technical thermoplastics primarily for manufacturing 50 housing components. The recovery in prices for plastic granulates 2013 2014 2015 2016 2017 begun in the second half of the previous year continued very dyn- amically in the year under review. This was due to growing demand Stainless steel Carbon steel Stainless steel and the increase in the price of oil throughout the year, coupled Carbon steel with scarce supply. Average prices increased by over 30% year-on- Sources: Carbon steel: Hot-rolled coil Germany (Ruhr) from Platts (€ per metric ton). year both on a U.S. dollar basis and on a euro basis. Stainless steel: 2 mm stainless steel 3042B cold-rolled Shanghai market price from Shanghai Steel Home E-Commerce Co., Ltd (€ per metric ton). Continental uses various types of natural rubber and synthetic rub- ber for the production of tires and industrial rubber products in the The base price for stainless steel in Europe was relatively stable in Rubber Group. It also uses relatively large quantities of carbon 2017 with an increase of around 2%. In contrast, the average alloy black as a filler material and of steel cord and nylon cord as struc- surcharges for the year rose by more than 30% year-on-year in tural materials. Due to the large quantities and direct purchasing of 2017. Chrome in particular became over 40% more expensive as raw materials, their price development, especially that of rubber, an annual average, while the average price increase for nickel was

64 Continental AG 2017 Annual Report Management Report Economic Report

has a significant influence on the earnings of the Rubber Group, Crude oil, butadiene and styrene indexed to January 1, 2013 particularly the Tire division. 200 After prices for natural rubber at the end of January 2017 had more than doubled since the seven-year low at the start of the pre- 150 vious year due to the weather-related supply shortage, they dropped significantly again, starting in mid-February 2017. This trend persisted until the end of the first half of the year. In the sec- 100 ond half of the year, natural rubber prices stabilized at the average level of the previous year due to the further increase in demand. 50 Overall, the average price of the natural rubber TSR 20 for the year increased by 20% on a U.S. dollar basis and 18% on a euro basis. The average price of ribbed smoked sheets (RSS) for the year in- 0 creased by 22% on a U.S. dollar basis and 20% on a euro basis. 2013 2014 2015 2016 2017

Styrene Natural rubber indexed to January 1, 2013 ButadieneBrent crude oil Butadiene Styrene B d l Sources: 125 Crude oil: Europe Brent Forties Oseberg Ekofisk price from Bloomberg (U.S. $ per barrel). Butadiene, styrene: South Korea export price (FOB) from PolymerUpdate.com (U.S. 100 $ per metric ton).

75 The average price of butadiene, the main input material for syn- 50 thetic rubber, for the year increased by over 30% year-on-year both on a U.S. dollar basis and on a euro basis in 2017. The scarcity- 25 related soaring price increase that began in the fourth quarter of the previous year peaked in February 2017. Subsequently, the in- 0 crease in supply and falling prices for natural rubber and crude oil 2013 2014 2015 2016 2017 divided the price of butadiene by three by the end of the first half

RSS 3 of the year. In the second half of the year, it then stabilized again TSR 20 RSS 3 TSR 20 above the average price level of the previous year. Source: Rolling one-month contracts from the Exchange (U.S. $ cents per kg). Other input materials for synthetic rubber mostly developed simi- larly to butadiene in 2017, but with lower volatility. For example, Price of crude oil – the most important basic building block for syn- the average price of styrene for the year increased by 18% on a thetic-rubber input materials such as butadiene and styrene and U.S. dollar basis and 16% on a euro basis. also for carbon black and various other chemicals – fell back below the U.S. $50 mark in the first half of 2017 from U.S. $55 per barrel Overall, the described price increases for the various raw materials at the start of the year. Although several major oil-exporting coun- led to considerable costs for Continental in 2017, which were tries cut their production, as announced at the end of 2016, and ex- passed on to customers via price adjustments only in part and with tended their production cuts to the start of 2018, other producers a delay. The Rubber Group was particularly affected by this in the stepped up their production in the first half of 2017. In addition, year under review. the U.S.A.’s withdrawal from the Paris climate agreement at the be- ginning of June caused the price of crude oil to fall below the U.S. $50 mark. In the second half of June, the price dropped to around U.S. $44 per barrel as a result of the excess supply, before stabiliz- ing slightly again. Several hurricanes impaired U.S. crude oil produc- tion in the second half of the year, whereupon prices increased again worldwide. In addition to the subsequent reduction in U.S. inventories, the announcement of an extension of the production cuts of several major oil-exporting countries beyond March 2018 triggered a price increase to over U.S. $60 at the end of the year. This was also supported by the rising demand following the very good performance of the global economy. The average price of crude oil for the year increased by over 20% year-on-year both on a U.S. dollar basis and on a euro basis.

Continental AG 2017 Annual Report Management Report Economic Report 65

Earnings, Financial and Net Assets Position

› Sales up 8.5% at €44.0 billion › Basic earnings per share at €14.92 › Free cash flow before acquisitions at €2.3 billion

Sales; EBIT € millions Free cash flow € millions

44,009.5 1,771.3 1,752.8 39,232.0 40,549.5 1,443.6

4,115.6 4,095.8 4,561.5

2015 2016 2017 2015 2016 2017

Sales by division % Net indebtedness € millions Gearing ratio %

Chassis & Safety 3,541.9 (PY: 22%) 22% Tires 26% (PY: 26%) 2,797.8

2,047.6

Powertrain ContiTech 26.8% (PY: 18%) 17% 14% (PY: 14%) 19.0% 12.6%

Interior (PY: 20%) 21% 2015 2016 2017

66 Continental AG 2017 Annual Report Management Report Economic Report

Earnings Position

› Sales up 8.5% › Sales up 8.1% before changes in the scope of consolidation and exchange-rate effects › Adjusted EBIT up 10.1%

Continental Corporation in € millions 2017 2016 ∆ in % Sales 44,009.5 40,549.5 8.5 EBITDA 6,678.9 6,057.4 10.3 in % of sales 15.2 14.9 EBIT 4,561.5 4,095.8 11.4 in % of sales 10.4 10.1 Net income attributable to the shareholders of the parent 2,984.6 2,802.5 6.5 Basic earnings per share in € 14.92 14.01 6.5 Research and development expenses (net) 3,103.7 2,811.5 10.4 in % of sales 7.1 6.9 Depreciation and amortization1 2,117.4 1,961.6 7.9

thereof impairment2 40.2 58.6 Operating assets as at December 31 22,213.6 21,068.7 5.4 Operating assets (average) 22,172.4 20,453.1 8.4

ROCE 20.6 20.0 Capital expenditure3 2,854.4 2,593.0 10.1 in % of sales 6.5 6.4 Number of employees as at December 314 235,473 220,137 7.0

Adjusted sales5 43,401.3 40,545.2 7.0 Adjusted operating result (adjusted EBIT)6 4,746.9 4,309.8 10.1 in % of adjusted sales 10.9 10.6

1 Excluding impairment on financial investments. 2 Impairment also includes necessary reversal of impairment losses. 3 Capital expenditure on property, plant and equipment, and software. 4 Excluding trainees. 5 Before changes in the scope of consolidation. 6 Before amortization of intangible assets from purchase price allocation (PPA), changes in the scope of consolidation, and special effects.

Sales up 8.5% Adjusted EBIT up 10.1% Sales up 8.1% before changes in the scope of The corporation’s adjusted EBIT increased by €437.1 million or consolidation and exchange-rate effects 10.1% year-on-year in 2017 to €4,746.9 million (PY: €4,309.8 mil- Consolidated sales climbed by €3,460.0 million or 8.5% year-on- lion), equivalent to 10.9% (PY: 10.6%) of adjusted sales. year in 2017 to €44,009.5 million (PY: €40,549.5 million). Before changes in the scope of consolidation and exchange-rate effects, The corporation’s adjusted EBIT for the fourth quarter of 2017 in- sales rose by 8.1%. The repeated sales increase resulted primarily creased by €44.7 million or 3.5% compared with the same quarter from the business performance in the Automotive Group, where of the previous year to €1,329.2 million (PY: €1,284.5 million), sales growth was significantly greater than the increase in the pro- equivalent to 11.9% (PY: 12.2%) of adjusted sales. duction of passenger cars, station wagons and light commercial ve- hicles. Consolidated sales grew fastest in Asia, especially in China.

Changes in the scope of consolidation contributed to the increase in sales, but were partially offset by negative exchange-rate effects.

Continental AG 2017 Annual Report Management Report Economic Report 67

The regional distribution of sales changed as follows in 2017 as compared to the previous year:

Sales by region in % 2017 2016 Germany 20 21 Europe excluding Germany 29 29 North America 25 26 Asia 22 21 Other countries 4 3

EBIT up 11.4% Special effects in 2016 EBIT was up by €465.7 million year-on-year in 2017 to €4,561.5 In the context of the plant closure in Melbourne, Australia, restruc- million (PY: €4,095.8 million), an increase of 11.4%. The return on turing expenses totaling €23.3 million were incurred in the Automo- sales rose to 10.4% (PY: 10.1%). tive Group (Chassis & Safety €0.2 million; Powertrain €1.0 million; Interior €22.1 million), of which €9.4 million was attributable to im- The amortization of intangible assets from purchase price alloca- pairment on property, plant and equipment. tion (PPA) reduced EBIT by €170.7 million (PY: €143.6 million) in the year under review. The planned closure of the location in Gravataí, Brazil, resulted in restructuring expenses totaling €4.4 million in the Interior division. ROCE amounted to 20.6% (PY: 20.0%). This included impairment on property, plant and equipment in the amount of €3.1 million. Special effects in 2017 Overall, impairment and a reversal of impairment losses on prop- The disposal of equity interests held as financial assets resulted in erty, plant and equipment resulted in expense of €22.2 million total income of €5.0 million (Powertrain €1.1 million; Tires €3.9 mil- (Chassis & Safety €0.5 million; Powertrain €18.8 million; Tires €0.5 lion). million; ContiTech €2.4 million). Due to the market situation in 2016, impairment totaling €33.1 mil- In addition, restructuring expenses and the reversal of restructuring lion on intangible assets was recognized for the Conveyor Belt provisions no longer required resulted in a total positive special ef- Group and Industrial Fluid Solutions business units in the ContiTech fect of €16.4 million (Chassis & Safety €0.1 million; Powertrain €0.7 division. million; Interior €5.4 million; Tires €10.0 million; ContiTech €0.2 mil- lion). This included €5.0 million from reversal of impairment losses A subsequent purchase price adjustment in connection with the on property, plant and equipment (Powertrain €0.2 million; Interior acquisition of Veyance Technologies resulted in income totaling €4.8 million). €27.0 million in the ContiTech division.

In the Interior division, goodwill totaling €23.0 million that arose in Other purchase price adjustments resulted in total expense of €1.0 connection with the expansion of our mobility-services activities million (Interior €0.1 million; ContiTech €0.9 million). was impaired, outside the scope of the annual impairment test. The sale of the steel cord business in Brazil, coupled with the fulfill- In addition, the acquisition of the remaining shares in a joint ven- ment of conditions imposed by antitrust authorities, resulted in ex- ture resulted in income of €1.9 million in the Interior division from pense totaling €15.9 million in the ContiTech division. This figure the adjustment of the market value of the previously held shares. comprises a loss on disposal of €9.3 million, market value adjust- ments totaling €6.0 million, and sales tax receivables that can no In the Tire division, the disposal of equity interests held as financial longer be utilized in the amount of €0.6 million. assets resulted in income totaling €14.0 million. In the ContiTech division, the temporary cessation of conveyor belt Moreover, a first-time consolidation resulted in a gain of €0.5 mil- production in Volos, Greece, resulted in restructuring expenses of lion in the Tire division. €11.2 million, of which €3.4 million was attributable to impairment on property, plant and equipment. In the ContiTech division, disposals of companies and assets re- sulted in an expense totaling €1.6 million. Restructuring expenses of €3.1 million were incurred in Chile in the ContiTech division. This included impairment on property, plant and Total consolidated expense from special effects in 2017 amounted equipment in the amount of €0.9 million. to €14.0 million. Further restructuring expenses and the reversal of restructuring provisions no longer required resulted in expense of €1.2 million (Powertrain €1.1 million; Interior income of €0.1 million; ContiTech

68 Continental AG 2017 Annual Report Management Report Economic Report

€0.2 million). This included reversal of impairment losses on prop- Procurement erty, plant and equipment for the ContiTech division in the amount The purchasing volume rose by around 13% year-on-year to €29.6 of €0.4 million. billion in 2017, of which approximately €20.2 billion was attributa- ble to production materials. The prices of key input materials and Other impairment and reversal of impairment losses on property, many raw materials for the Rubber Group peaked in the first half plant and equipment resulted in expense totaling €9.1 million of 2017. In the following months, the raw materials prices then (Chassis & Safety €1.3 million; Powertrain €7.6 million; Tires dropped considerably. Due to the very sharp increase in the price €0.2 million; ContiTech €0.0 million). level at the start of the year, raw materials were more expensive on average during the year than in the previous year. By contrast, Total consolidated expense from special effects in 2016 amounted prices for the Automotive Group’s productions materials were lower to €70.3 million. than in the previous year.

Reconciliation of EBIT to net income

€ millions 2017 2016 ∆ in % Chassis & Safety 897.7 580.8 54.6 Powertrain 439.9 378.0 16.4 Interior 749.2 567.8 31.9 Tires 2,151.3 2,289.4 –6.0 ContiTech 442.2 399.2 10.8 Other/consolidation –118.8 –119.4 –0.5

EBIT 4,561.5 4,095.8 11.4 Financial result –285.7 –117.0 144.2

Earnings before tax 4,275.8 3,978.8 7.5 Income tax expense –1,227.5 –1,096.8 11.9

Net income 3,048.3 2,882.0 5.8 Non-controlling interests –63.7 –79.5 –19.9

Net income attributable to the shareholders of the parent 2,984.6 2,802.5 6.5 Basic earnings per share in € 14.92 14.01 6.5

Continental AG 2017 Annual Report Management Report Economic Report 69

Reconciliation of sales to adjusted sales and of EBITDA to adjusted operating result (adjusted EBIT) 2017

Other/ Continental € millions Chassis & Safety Powertrain Interior Tires ContiTech consolidation Corporation Sales 9,767.8 7,660.9 9,305.2 11,325.8 6,246.4 –296.6 44,009.5 Changes in the scope of consolidation1 — –8.0 –70.9 –131.1 –398.2 — –608.2

Adjusted sales 9,767.8 7,652.9 9,234.3 11,194.7 5,848.2 –296.6 43,401.3

EBITDA 1,301.6 854.8 1,140.0 2,748.7 750.9 –117.1 6,678.9 Depreciation and amortization2 –403.9 –414.9 –390.8 –597.4 –308.7 –1.7 –2,117.4

EBIT 897.7 439.9 749.2 2,151.3 442.2 –118.8 4,561.5 Amortization of intangible assets from purchase price allocation (PPA) 0.0 11.9 46.1 19.5 93.2 — 170.7 Changes in the scope of consolidation1 — 3.6 39.5 –18.6 –23.8 — 0.7

Special effects Impairment3 0.5 18.8 23.0 0.5 2.4 — 45.2 Restructuring4 –0.1 –0.7 –5.4 –10.0 –0.2 — –16.4 Gains and losses from disposals of companies and business operations — — — –14.0 1.6 — –12.4 Other — — –1.9 –0.5 — — –2.4

Adjusted operating result (adjusted EBIT) 898.1 473.5 850.5 2,128.2 515.4 –118.8 4,746.9

Reconciliation of sales to adjusted sales and of EBITDA to adjusted operating result (adjusted EBIT) 2016

Other/ Continental € millions Chassis & Safety Powertrain Interior Tires ContiTech consolidation Corporation

Sales 8,977.6 7,319.5 8,324.7 10,717.4 5,462.5 –252.2 40,549.5 Changes in the scope of consolidation1 — — — –0.8 –3.5 — –4.3

Adjusted sales 8,977.6 7,319.5 8,324.7 10,716.6 5,459.0 –252.2 40,545.2

EBITDA 954.6 756.2 904.2 2,828.7 730.9 –117.2 6,057.4 Depreciation and amortization2 –373.8 –378.2 –336.4 –539.3 –331.7 –2.2 –1,961.6

EBIT 580.8 378.0 567.8 2,289.4 399.2 –119.4 4,095.8 Amortization of intangible assets from purchase price allocation (PPA) 0.3 11.5 38.4 10.7 82.7 — 143.6 Changes in the scope of consolidation1 — — — 0.2 –0.1 — 0.1

Special effects Impairment3 1.3 7.6 0.0 0.2 33.1 — 42.2 Restructuring5 0.2 2.1 26.4 — 14.5 — 43.2 Gains and losses from disposals of companies and business operations — –1.1 0.1 –3.9 10.2 — 5.3 Other — — — — –20.4 — –20.4

Adjusted operating result (adjusted EBIT) 582.6 398.1 632.7 2,296.6 519.2 –119.4 4,309.8

1 Changes in the scope of consolidation include additions and disposals as part of share and asset deals. Adjustments were made for additions in the reporting year and for disposals in the comparative period of the prior year. 2 Excluding impairment on financial investments. 3 Impairment also includes necessary reversal of impairment losses. This item does not include impairment that arose in connection with a restructuring and impairment on financial investments. 4 This includes reversal of impairment losses totaling €5.0 million (Powertrain €0.2 million; Interior €4.8 million). 5 This includes impairment and reversal of impairment losses totaling €16.4 million (Chassis & Safety €0.2 million; Powertrain €0.7 million; Interior €11.6 million; ContiTech €3.9 million).

70 Continental AG 2017 Annual Report Management Report Economic Report

Research and Development year decline in this expense is attributable to the repayment of the Research and development expenses (net) rose by €292.2 million €750.0 million euro bond from Conti-Gummi Finance B.V., Maas- or 10.4% year-on-year to €3,103.7 million (PY: €2,811.5 million), tricht, Netherlands, on March 20, 2017. The 3.5-year bond bore corresponding to 7.1% (PY: 6.9%) of sales. interest at a rate of 2.5% p.a. The interest expense from long-term employee benefits totaled €151.5 million (PY: €168.2 million) in In the Chassis & Safety, Powertrain and Interior divisions, costs in 2017. This does not include the interest expense from the defined connection with initial product development projects in the original- benefit obligations of the pension contribution funds. equipment business are capitalized. Costs are capitalized as at the time at which we are named as a supplier and have successfully The effects from currency translation resulted in a negative contri- achieved a specific pre-release stage. Capitalization ends with the bution to earnings of €138.8 million (PY: positive contribution to approval for unlimited volume production. The costs of customer- earnings of €157.1 million) in 2017. This was countered by effects specific applications, pre-production prototypes and testing for prod- from changes in the fair value of derivative instruments, and other ucts already being sold do not qualify as development expenditure valuation effects, which resulted in earnings of €40.2 million (PY: that may be recognized as an intangible asset. Capitalized develop- expense of €66.7 million) in 2017. The available-for-sale financial ment expenses are amortized on a straight-line basis over a useful assets accounted for income of €1.8 million (PY: €0.3 million) of life of three to seven years and recognized in the cost of sales. In this. Taking into account the sum of the effects from currency Continental’s opinion, the assumed useful life reflects the period for translation and changes in the fair value of derivative instruments, which an economic benefit is likely to be derived from the corre- earnings were negatively impacted by €100.4 million (PY: income sponding development projects. €92.1 million (PY: €105.9 million) of €90.1 million) in 2017. This resulted primarily from the develop- of the development costs incurred in the three divisions in 2017 ment of the Mexican peso in relation to the U.S. dollar, which re- qualified for recognition as an asset. sulted in a positive contribution to earnings in the previous year, and of the Brazilian real in relation to the euro. The requirements for the capitalization of development activities were not met in the Tire and ContiTech divisions in the year under Income tax expense review or the previous year. Income tax expense for fiscal 2017 amounted to €1,227.5 million (PY: €1,096.8 million). The tax rate was 28.7% after 27.6% in the This results in a capitalization ratio of 2.9% (PY: 3.6%) for the corpo- previous year. ration. As in the previous year, foreign tax rate differences, incentives and Depreciation and amortization tax holidays had positive effects in the year under review. The tax Depreciation and amortization increased by €155.8 million to rate was negatively impacted by non-cash allowances on deferred €2,117.4 million (PY: €1,961.6 million), equivalent to 4.8% of sales tax assets totaling €91.0 million (PY: €78.6 million), of which €40.2 as in the previous year. This included impairment totaling €40.2 million (PY: €11.7 million) was for previous years. Furthermore, as in million (PY: €58.6 million). the previous year, the tax rate was negatively affected by non-de- ductible expenses and non-imputable foreign withholding tax. Financial result The negative financial result increased by €168.7 million year-on- Net income attributable to the shareholders of the parent year to €285.7 million (PY: €117.0 million) in 2017. This is primar- The net income attributable to the shareholders of the parent ily attributable to the sum of the effects from changes in the fair increased by €182.1 million in 2017 to €2,984.6 million (PY: value of derivative instruments and from currency translation. €2,802.5 million). This corresponds to earnings per share of €14.92 (PY: €14.01). Interest income in 2017 decreased by €7.0 million year-on-year to €94.4 million (PY: €101.4 million). Of this, expected income from long-term employee benefits and from pension funds amounted to €67.8 million (PY: €75.9 million). This does not include the interest income from the plan assets of the pension contribution funds.

Interest expense totaled €281.5 million in 2017 and was thus €27.3 million lower than the previous year’s figure of €308.8 mil- lion. At €130.0 million, interest expense resulting from bank bor- rowings, capital market transactions, and other financing instru- ments was €10.6 million lower than the prior-year figure of €140.6 million. The major portion related to expense of €70.7 million (PY: €86.1 million) from the bonds issued by Continental AG, Conti- Gummi Finance B.V., Maastricht, Netherlands, and Continental Rub- ber of America, Corp., Wilmington, Delaware, U.S.A. The year-on-

Continental AG 2017 Annual Report Management Report Economic Report 71

Employees research and development. In the Rubber Group, the increase The number of employees in the Continental Corporation rose by in the number of employees by 5,783 was chiefly attributable to 15,336 from 220,137 in 2016 to 235,473. The number of employ- the expansion of production capacity and sales channels and to ees in the Automotive Group rose by 9,533, as a result in particular the acquisition of the Hornschuch Group in the ContiTech division. of increased production volumes and the continuous expansion of

Employees by region in % 2017 2016 Germany 26 26 Europe excluding Germany 32 32 North America 19 19 Asia 19 19 Other countries 4 4

72 Continental AG 2017 Annual Report Management Report Economic Report

Financial Position Based on quarter-end values, 59.6% (PY: 62.6%) of gross indebted- ness after hedging measures had fixed interest rates on average over the year. › Free cash flow before acquisitions at €2.3 billion › Cash flow arising from investing activities at €3.5 billion The carrying amount of the bonds fell by €744.1 million from › Net indebtedness at €2.0 billion €3,383.5 million in the previous year to €2,639.4 million as at the end of fiscal 2017. This decline is attributable to the repayment of the €750.0 million euro bond from Conti-Gummi Finance B.V., Reconciliation of cash flow Maastricht, Netherlands. The 3.5-year bond bore interest at a rate EBIT increased by €465.7 million to €4,561.5 million after of 2.5% p.a. and was redeemed at a rate of 100.00% at its maturity €4,095.8 million in 2016. on March 20, 2017.

Interest payments resulting in particular from bonds decreased by Bank loans and overdrafts amounted to €859.7 million (PY: €931.9 €4.6 million to €131.5 million (PY: €136.1 million). million) as at December 31, 2017, and were therefore down €72.2 million on the previous year’s level. Income tax payments increased by €74.8 million to €1,122.1 mil- lion (PY: €1,047.3 million). The syndicated loan comprises a revolving tranche of €3,000.0 million. This credit line is available to Continental until April 2021 The cash-effective increase in working capital led to a cash outflow and had not been utilized at the end of 2017 or in the previous of €483.8 million (PY: €210.1 million). This resulted from the €484.3 year. million increase in inventories (PY: €326.5 million). The increase in operating receivables in the amount of €737.1 million (PY: €631.7 Other indebtedness decreased by €46.0 million to €590.9 million million) was offset by the increase in operating liabilities in the (PY: €636.9 million) as at the end of 2017. This decrease was pri- amount of €737.6 million (PY: €748.1 million). marily due to lower negative fair values of derivative instruments. At the end of 2017, the utilization of sale-of-receivables programs Cash flow from operating activities rose by €282.4 million year-on- amounted to €513.7 million, up slightly from the previous year’s year to €5,220.5 million (PY: €4,938.1 million) in 2017, corre- €487.1 million. As in the previous year, five sale-of-receivables sponding to 11.9% (PY: 12.2%) of sales. programs with a total financing volume of €894.5 million (PY: €1,069.3 million) were used within the Continental Corporation Cash flow arising from investing activities amounted to an outflow as at the end of 2017. of €3,467.7 million (PY: €3,166.8 million). Capital expenditure on property, plant and equipment, and software was up €257.2 million Cash and cash equivalents, derivative instruments and interest- from €2,592.5 million to €2,849.7 million before finance leases and bearing investments were down by €112.1 million at €2,042.4 mil- the capitalization of borrowing costs. The net amount from the ac- lion (PY: €2,154.5 million). quisition and disposal of companies and business operations re- sulted in a total cash outflow of €575.9 million (PY: €511.6 million) Net indebtedness decreased by a considerable €750.2 million as in 2017. This cash outflow is chiefly attributable to the acquisitions compared to the end of 2016 to €2,047.6 million (PY: €2,797.8 of the Hornschuch Group and Argus Cyber Security Ltd, Tel Aviv, million). The gearing ratio also improved significantly year-on-year Israel. to 12.6% (PY: 19.0%).

Free cash flow for fiscal 2017 amounted to €1,752.8 million (PY: As at December 31, 2017, Continental had liquidity reserves total- €1,771.3 million). This corresponds to a decrease of €18.5 million ing €5,568.3 million (PY: €5,995.4 million), consisting of cash and compared with the previous year. cash equivalents of €1,881.5 million (PY: €2,107.0 million) and committed, unutilized credit lines totaling €3,686.8 million (PY: Capital expenditure (additions) €3,888.4 million). Capital expenditure for property, plant and equipment, and soft- ware amounted to €2,854.4 million in 2017. Overall, there was an The restrictions that may impact the availability of capital are also increase of €261.4 million compared with the previous year’s level understood as comprising all existing restrictions on the cash and of €2,593.0 million, to which the Chassis & Safety, Powertrain and cash equivalents. In the Continental Corporation, the aforemen- Interior divisions contributed. Capital expenditure amounted to tioned cash and cash equivalents are restricted with regard to 6.5% (PY: 6.4%) of sales. pledged amounts and balances in countries with foreign-exchange restrictions or other barriers to accessing liquidity. Taxes to be paid Financing and indebtedness on the transfer of cash assets from one country to another are not As at the end of 2017, gross indebtedness amounted to €4,090.0 usually considered to represent a restriction on cash and cash million (PY: €4,952.3 million), down €862.3 million on the previous equivalents. As at December 31, 2017, unrestricted cash and cash year’s level. equivalents totaled €1,726.7 million (PY: €1,673.9 million).

Continental AG 2017 Annual Report Management Report Economic Report 73

Reconciliation of net indebtedness

€ millions Dec. 31, 2017 Dec. 31, 2016 Long-term indebtedness 2,017.8 2,803.7 Short-term indebtedness 2,072.2 2,148.6 Long-term derivative instruments and interest-bearing investments –113.3 –19.7 Short-term derivative instruments and interest-bearing investments –47.6 –27.8 Cash and cash equivalents –1,881.5 –2,107.0

Net indebtedness 2,047.6 2,797.8

Reconciliation of change in net indebtedness

€ millions 2017 2016

Net indebtedness at the beginning of the reporting period 2,797.8 3,541.9

Cash flow arising from operating activities 5,220.5 4,938.1 Cash flow arising from investing activities –3,467.7 –3,166.8

Cash flow before financing activities (free cash flow) 1,752.8 1,771.3 Dividends paid –850.0 –750.0 Dividends paid to and cash changes from equity transactions with non-controlling interests –46.5 –55.6 Non-cash changes 16.5 –39.9 Other –151.6 –112.4 Exchange-rate effects 29.0 –69.3

Change in net indebtedness 750.2 744.1

Net indebtedness at the end of the reporting period 2,047.6 2,797.8

74 Continental AG 2017 Annual Report Management Report Economic Report

Net Assets Position Non-current liabilities At €6,961.5 million, non-current liabilities were down €924.4 mil- lion from €7,885.9 million in the previous year. This was mainly at- › Equity at €16.3 billion tributable to the €785.9 million reduction in long-term indebted- › Equity ratio at 43.5% ness to €2,017.8 million (PY: €2,803.7 million). This in turn resulted › Gearing ratio at 12.6% from the reclassification of a Continental AG euro bond with a nom- inal volume of €750.0 million as short-term indebtedness on the basis of its maturity. Total assets At €37,440.5 million (PY: €36,174.9 million), total assets as at De- Current liabilities cember 31, 2017, were €1,265.6 million higher than on the same At €14,188.7 million, current liabilities were up €634.5 million from date in the previous year. Goodwill, at €7,010.1 million, was up by €13,554.2 million in the previous year. Short-term employee bene- €152.8 million compared to the previous year’s figure of €6,857.3 fits increased by €176.5 million to €1,490.6 million (PY: €1,314.1 million. Other intangible assets climbed by €93.2 million to million), trade accounts payable by €550.5 million to €6,798.5 mil- €1,607.3 million (PY: €1,514.1 million). Property, plant and equip- lion (PY: €6,248.0 million) and income tax liabilities by €106.1 mil- ment increased by €664.0 million to €11,202.1 million (PY: lion to €889.7 million (PY: €783.6 million). In contrast, short-term €10,538.1 million). Deferred tax assets were down €318.9 million provisions for other risks and obligations decreased by €203.4 mil- at €1,517.2 million (PY: €1,836.1 million). Inventories rose by lion to €943.0 million (PY: €1,146.4 million). €375.0 million to €4,128.2 million (PY: €3,753.2 million) and trade accounts receivable increased by €276.6 million to €7,669.3 mil- Operating assets lion (PY: €7,392.7 million), both as a result of the growth in busi- Operating assets increased by €1,144.9 million year-on-year to ness activities. Short-term other assets decreased by €34.7 million €22,213.6 million (PY: €21,068.7 million) as at December 31, to €954.3 million (PY: €989.0 million). At €1,881.5 million, cash 2017. and cash equivalents were down €225.5 million from €2,107.0 mil- lion on the same date in the previous year. Total working capital was up €234.9 million at €5,206.0 million (PY: €4,971.1 million). This development was due to the €410.4 million Non-current assets increase in operating receivables to €7,876.3 million (PY: €7,465.9 Non-current assets rose by €717.4 million to €22,038.4 million million) and the €375.0 million rise in inventories to €4,128.2 mil- (PY: €21,321.0 million) year-on-year. In relation to the individual lion (PY: €3,753.2 million). This was countered by the €550.5 mil- items of the statement of financial position, this is due primarily lion increase in operating liabilities to €6,798.5 million (PY: to the €152.8 million increase in goodwill to €7,010.1 million (PY: €6,248.0 million). €6,857.3 million), the €93.2 million increase in other intangible as- sets to €1,607.3 million (PY: €1,514.1 million), the €664.0 million Non-current operating assets were up €955.1 million year-on-year increase in property, plant and equipment to €11,202.1 million (PY: at €20,387.2 million (PY: €19,432.1 million). Goodwill increased €10,538.1 million) and the €318.9 million decrease in deferred tax by €152.8 million to €7,010.1 million (PY: €6,857.3 million). This assets to €1,517.2 million (PY: €1,836.1 million). change primarily resulted from additions of €299.2 million, which were countered by exchange-rate effects of €123.4 million and al- Current assets lowances of €23.0 million. Property, plant and equipment increased At €15,402.1 million, current assets were €548.2 million higher by €664.0 million to €11,202.1 million (PY: €10,538.1 million) due than the previous year’s figure of €14,853.9 million. In the year un- to investing activities. Other intangible assets climbed by €93.2 mil- der review, inventories rose by €375.0 million to €4,128.2 million lion to €1,607.3 million (PY: €1,514.1 million). Amortization of in- (PY: €3,753.2 million) and trade accounts receivable increased by tangible assets from purchase price allocation (PPA) in the amount €276.6 million to €7,669.3 million (PY: €7,392.7 million). Cash and of €170.7 million (PY: €143.6 million) reduced the value of intangi- cash equivalents declined by €225.5 million to €1,881.5 million ble assets. (PY: €2,107.0 million). In the Interior division, the acquisition of Argus Cyber Security Ltd, Equity Tel Aviv, Israel, at €353.4 million and two share deals totaling €32.4 Equity was €1,555.5 million higher than in the previous year at million resulted in an increase in operating assets. €16,290.3 million (PY: €14,734.8 million). This was due primarily to the increase in retained earnings of €2,134.6 million. The gearing ratio improved from 19.0% to 12.6%. The equity ratio rose from 40.7% to 43.5% in the period under review.

Continental AG 2017 Annual Report Management Report Economic Report 75

Consolidated statement of financial position

Assets in € millions Dec. 31, 2017 Dec. 31, 2016 Goodwill 7,010.1 6,857.3 Other intangible assets 1,607.3 1,514.1 Property, plant and equipment 11,202.1 10,538.1 Investments in equity-accounted investees 414.8 384.8 Long-term miscellaneous assets 1,804.1 2,026.7

Non-current assets 22,038.4 21,321.0 Inventories 4,128.2 3,753.2 Trade accounts receivable 7,669.3 7,392.7 Short-term miscellaneous assets 1,723.1 1,601.0 Cash and cash equivalents 1,881.5 2,107.0

Current assets 15,402.1 14,853.9 Total assets 37,440.5 36,174.9

Equity and liabilities in € millions Dec. 31, 2017 Dec. 31, 2016

Total equity 16,290.3 14,734.8 Non-current liabilities 6,961.5 7,885.9 Trade accounts payable 6,798.5 6,248.0 Short-term other provisions and liabilities 7,390.2 7,306.2

Current liabilities 14,188.7 13,554.2 Total equity and liabilities 37,440.5 36,174.9

Net indebtedness 2,047.6 2,797.8 Gearing ratio in % 12.6 19.0

In connection with several asset deals and a purchase price adjust- While exchange-rate effects increased the corporation’s total oper- ment, operating assets in the Tire division rose by €5.7 million over- ating assets by €221.5 million in the previous year, they reduced all. them by €900.7 million in the year under review.

The acquisition of the Hornschuch Group at €463.0 million and a Average operating assets rose by €1,719.3 million to €22,172.4 share deal at €14.9 million contributed to an increase in the Conti- million as compared to the previous year (€20,453.1 million). Tech division’s operating assets.

Other changes in the scope of consolidation did not result in any notable additions to or disposal of operating assets at corporation level.

76 Continental AG 2017 Annual Report Management Report Economic Report

Reconciliation to operating assets in 2017

Other/ Continental € millions Chassis & Safety Powertrain Interior Tires ContiTech consolidation Corporation Total assets 7,330.8 5,413.4 7,619.0 8,421.1 4,348.0 4,308.2 37,440.5 Cash and cash equivalents — — — — — 1,881.5 1,881.5 Short- and long-term derivative instruments, interest-bearing investments — — — — — 160.9 160.9 Other financial assets 10.0 39.4 18.7 23.3 6.6 2.9 100.9

Less financial assets 10.0 39.4 18.7 23.3 6.6 2,045.3 2,143.3 Less other non-operating assets –30.1 –56.1 –69.1 –34.3 –1.4 535.5 344.5 Deferred tax assets — — — — — 1,517.2 1,517.2 Income tax receivables — — — — — 178.2 178.2

Less income tax assets — — — — — 1,695.4 1,695.4 Segment assets 7,350.9 5,430.1 7,669.4 8,432.1 4,342.8 32.0 33,257.3

Total liabilities and provisions 4,003.1 2,835.8 3,083.3 3,315.4 1,797.7 6,114.9 21,150.2 Short- and long-term indebtedness — — — — — 4,090.0 4,090.0 Interest payable and other financial liabilities — — — — — 81.8 81.8

Less financial liabilities — — — — — 4,171.8 4,171.8 Deferred tax liabilities — — — — — 348.5 348.5 Income tax payables — — — — — 889.7 889.7

Less income tax liabilities — — — — — 1,238.2 1,238.2 Less other non-operating liabilities 1,197.8 806.5 654.7 879.0 532.8 625.7 4,696.5 Segment liabilities 2,805.3 2,029.3 2,428.6 2,436.4 1,264.9 79.2 11,043.7

Operating assets 4,545.6 3,400.8 5,240.8 5,995.7 3,077.9 –47.2 22,213.6

Continental AG 2017 Annual Report Management Report Economic Report 77

Reconciliation to operating assets in 2016

Other/ Continental € millions Chassis & Safety Powertrain Interior Tires ContiTech consolidation Corporation Total assets 7,118.5 5,163.0 7,030.2 8,095.8 3,986.8 4,780.6 36,174.9 Cash and cash equivalents — — — — — 2,107.0 2,107.0 Short- and long-term derivative instruments, interest-bearing investments — — — — — 47.5 47.5 Other financial assets 10.6 42.5 14.7 20.4 7.2 18.0 113.4

Less financial assets 10.6 42.5 14.7 20.4 7.2 2,172.5 2,267.9 Less other non-operating assets — 0.4 –44.2 –11.1 5.9 616.3 567.3 Deferred tax assets — — — — — 1,836.1 1,836.1 Income tax receivables — — — — — 124.7 124.7

Less income tax assets — — — — — 1,960.8 1,960.8 Segment assets 7,107.9 5,120.1 7,059.7 8,086.5 3,973.7 31.0 31,378.9

Total liabilities and provisions 3,877.4 2,766.6 2,990.4 3,295.3 1,644.7 6,865.7 21,440.1 Short- and long-term indebtedness — — — — — 4,952.3 4,952.3 Interest payable and other financial liabilities — — — — — 101.9 101.9

Less financial liabilities — — — — — 5,054.2 5,054.2 Deferred tax liabilities — — — — — 371.5 371.5 Income tax payables — — — — — 783.6 783.6

Less income tax liabilities — — — — — 1,155.1 1,155.1 Less other non-operating liabilities 1,279.0 871.7 689.6 980.7 539.5 560.1 4,920.6 Segment liabilities 2,598.4 1,894.9 2,300.8 2,314.6 1,105.2 96.3 10,310.2

Operating assets 4,509.5 3,225.2 4,758.9 5,771.9 2,868.5 –65.3 21,068.7

78 Continental AG 2017 Annual Report Management Report Economic Report

Automotive Group

Automotive Group in € millions 2017 2016 ∆ in % Sales 26,565.4 24,496.4 8.4 EBITDA 3,296.4 2,615.0 26.1 in % of sales 12.4 10.7 EBIT 2,086.8 1,526.6 36.7 in % of sales 7.9 6.2 Research and development expenses (net) 2,675.5 2,430.9 10.1 in % of sales 10.1 9.9 Depreciation and amortization1 1,209.6 1,088.4 11.1

thereof impairment2 37.3 21.4 Operating assets as at December 31 13,187.2 12,493.6 5.6 Operating assets (average) 12,874.1 11,978.3 7.5

ROCE 16.2 12.7 Capital expenditure3 1,789.5 1,497.0 19.5 in % of sales 6.7 6.1 Number of employees as at December 314 134,286 124,753 7.6

Adjusted sales5 26,486.5 24,496.4 8.1 Adjusted operating result (adjusted EBIT)6 2,222.1 1,613.4 37.7 in % of adjusted sales 8.4 6.6

1 Excluding impairment on financial investments. 2 Impairment also includes necessary reversal of impairment losses. 3 Capital expenditure on property, plant and equipment, and software. 4 Excluding trainees. 5 Before changes in the scope of consolidation. 6 Before amortization of intangible assets from purchase price allocation (PPA), changes in the scope of consolidation, and special effects.

The Automotive Group comprises three divisions: The 14 business units in total generated 60% of consolidated sales in the year under review. › The Chassis & Safety division (22% of consolidated sales) devel- ops, produces and markets intelligent systems to improve driving Key raw materials for the Automotive Group are steel, aluminum, safety and vehicle dynamics. precious metals, copper and plastics. One point of focus when it comes to purchasing materials and semifinished products is elec- › The Powertrain division (17% of consolidated sales) combines tronics and electromechanical components, which together make innovative and efficient system solutions for the powertrains of up more than 40% of the corporation’s purchasing volume for pro- today and tomorrow. duction material.

› The Interior division (21% of consolidated sales) specializes in information management. It develops and produces information, communication and network solutions for cars and commercial vehicles.

Continental AG 2017 Annual Report Management Report Economic Report 79

Development of the EBIT up 54.6% Chassis & Safety Division In comparison to the previous year, the Chassis & Safety division posted an increase in EBIT of €316.9 million, or 54.6%, to €897.7 million (PY: €580.8 million) in 2017. The return on sales climbed to 9.2% (PY: 6.5%). It should be noted that several isolated events had Sales up 8.8% › a negative impact on the result in the third quarter of the previous Sales up 10.4% before changes in the scope of › year. consolidation and exchange-rate effects Adjusted EBIT up 54.2% › The amortization of intangible assets from purchase price alloca- tion (PPA) had no notable effect on EBIT (PY: reduction of €0.3 mil- Sales volumes lion). In the Vehicle Dynamics business unit, the number of electronic brake systems sold in 2017 increased by 9% year-on-year. In the ROCE amounted to 19.9% (PY: 13.1%). Hydraulic Brake Systems business unit, sales figures for brake boosters were up 6% compared to the previous year. Sales of brake Special effects in 2017 calipers with integrated electric parking brakes increased by 33% An impairment loss and a reversal of impairment loss on property, year-on-year, more than compensating for the decline in sales fig- plant and equipment resulted in total expense of €0.5 million in the ures for conventional brake calipers, which decreased by 3% year- Chassis & Safety division. on-year. In the Passive Safety & Sensorics business unit, the sales volume of air-bag control units rose by 21% year-on-year. Unit sales In addition, the reversal of a restructuring provision resulted in of advanced driver assistance systems were up 41%. income of €0.1 million.

Sales up 8.8% Special effects in 2017 had a negative impact totaling €0.4 million Sales up 10.4% before changes in the scope of in the Chassis & Safety division. consolidation and exchange-rate effects Sales in the Chassis & Safety division rose by 8.8% year-on-year to Special effects in 2016 €9,767.8 million (PY: €8,977.6 million) in 2017. Before changes in Impairment and reversal of impairment losses on property, plant the scope of consolidation and exchange-rate effects, sales rose by and equipment resulted in expense totaling €1.3 million. 10.4%. In the context of the plant closure in Melbourne, Australia, restruc- Sales € millions turing expenses of €0.2 million were incurred in the Chassis & Safety division. These expenses were attributable to impairment on 9,767.8 property, plant and equipment. 8,977.6 8,449.7 Special effects in 2016 had a negative impact totaling €1.5 million in the Chassis & Safety division.

Procurement The procurement market for Chassis & Safety saw stable develop- ment in 2017, but occasional bottlenecks arose at upstream raw material suppliers. There were considerable supply problems with regard to semiconductors from a Japanese supplier whose produc- tion activities were affected by earthquakes in 2016. The upward 2015 2016 2017 trend in prices for industrial metals begun in the previous year con- tinued in 2017. The import duties charged on flat steels in Europe and the U.S.A. caused a significant rise in their prices. Adjusted EBIT up 54.2% The Chassis & Safety division’s adjusted EBIT increased by €315.5 Research and development million or 54.2% year-on-year in 2017 to €898.1 million (PY: €582.6 Research and development expenses (net) rose by €140.4 million million), equivalent to 9.2% (PY: 6.5%) of adjusted sales. It should be or 18.2% year-on-year to €913.8 million (PY: €773.4 million), corre- noted that several isolated events had a negative impact on the re- sponding to 9.4% (PY: 8.6%) of sales. sult in the third quarter of the previous year. Depreciation and amortization Depreciation and amortization rose by €30.1 million compared to fiscal 2016 to €403.9 million (PY: €373.8 million) and amounted to 4.1% (PY: 4.2%) of sales. This included impairment totaling €0.5 mil- lion in 2017 (PY: €1.5 million).

80 Continental AG 2017 Annual Report Management Report Economic Report

Chassis & Safety in € millions 2017 2016 ∆ in % Sales 9,767.8 8,977.6 8.8 EBITDA 1,301.6 954.6 36.4 in % of sales 13.3 10.6 EBIT 897.7 580.8 54.6 in % of sales 9.2 6.5 Research and development expenses (net) 913.8 773.4 18.2 in % of sales 9.4 8.6 Depreciation and amortization1 403.9 373.8 8.1

thereof impairment2 0.5 1.5 Operating assets as at December 31 4,545.6 4,509.5 0.8 Operating assets (average) 4,519.6 4,448.7 1.6

ROCE 19.9 13.1 Capital expenditure3 682.5 523.7 30.3 in % of sales 7.0 5.8 Number of employees as at December 314 47,788 43,907 8.8

Adjusted sales5 9,767.8 8,977.6 8.8 Adjusted operating result (adjusted EBIT)6 898.1 582.6 54.2 in % of adjusted sales 9.2 6.5

1 Excluding impairment on financial investments. 2 Impairment also includes necessary reversal of impairment losses. 3 Capital expenditure on property, plant and equipment, and software. 4 Excluding trainees. 5 Before changes in the scope of consolidation. 6 Before amortization of intangible assets from purchase price allocation (PPA), changes in the scope of consolidation, and special effects.

Operating assets The reversal of a purchase price liability resulted in a €3.3 million Operating assets in the Chassis & Safety division rose by €36.1 increase in operating assets in the Chassis & Safety division. Other million year-on-year to €4,545.6 million (PY: €4,509.5 million) as changes in the scope of consolidation did not result in any addi- at December 31, 2017. tions or disposals of operating assets.

Working capital was down €132.7 million at €606.5 million (PY: While exchange-rate effects increased the Chassis & Safety divi- €739.2 million). This change was due primarily to the €168.0 sion’s total operating assets by €8.6 million in the previous year, million increase in operating liabilities to €1,608.4 million (PY: they reduced them by €122.2 million in the year under review. €1,440.4 million), which was countered by a €20.1 million rise in inventories to €505.8 million (PY: €485.7 million) and the €15.2 Average operating assets in the Chassis & Safety division climbed million increase in operating receivables to €1,709.1 million (PY: by €70.9 million to €4,519.6 million as compared to fiscal 2016 €1,693.9 million). (€4,448.7 million).

Non-current operating assets were up €155.6 million year-on-year Capital expenditure (additions) at €4,911.5 million (PY: €4,755.9 million). Goodwill decreased by Additions to the Chassis & Safety division rose by €158.8 million €26.7 million to €2,630.7 million (PY: €2,657.4 million) as a result year-on-year to €682.5 million (PY: €523.7 million). Capital expendi- of exchange-rate effects. Property, plant and equipment increased ture amounted to 7.0% (PY: 5.8%) of sales. by €203.8 million to €2,079.8 million (PY: €1,876.0 million) due to investing activities. Other intangible assets declined by €20.8 mil- In addition to increasing production capacity in Europe, production lion to €82.2 million (PY: €103.0 million). There was no notable facilities were also expanded in North America and Asia. The pro- amortization of intangible assets from purchase price allocation duction capacities of all business units were hereby increased. Im- (PPA) in the year under review (PY: €0.3 million). portant additions related to the creation of new production facilities for electronic brake systems.

Continental AG 2017 Annual Report Management Report Economic Report 81

Employees The number of employees in the Chassis & Safety division rose by 3,881 to 47,788 (PY: 43,907). In all business units, the increase in staff numbers was due to an adjustment in line with greater sales volumes. In addition, the continuous expansion of research and de- velopment activities, particularly in the Advanced Driver Assistance Systems and Vehicle Dynamics business units, also led to a rise in the number of employees. Capacity was increased in all business units, particularly in best-cost countries.

82 Continental AG 2017 Annual Report Management Report Economic Report

Development of the Powertrain Division EBIT up 16.4% In comparison to the previous year, the Powertrain division posted an increase in EBIT of €61.9 million, or 16.4%, to €439.9 million › Sales up 4.7% (PY: €378.0 million) in 2017. The return on sales rose to 5.7% › Sales up 5.6% before changes in the scope of (PY: 5.2%). consolidation and exchange-rate effects › Adjusted EBIT up 18.9% The amortization of intangible assets from purchase price alloca- tion (PPA) reduced EBIT by €11.9 million (PY: €11.5 million).

Sales volumes ROCE amounted to 13.2% (PY: 12.5%). In the Engine Systems business unit, sales volumes of engine con- trol units, injectors, pumps and turbochargers increased in fiscal Special effects in 2017 2017. The Sensors & Actuators business unit is continuing to record Impairment on property, plant and equipment resulted in expense growth. Emissions legislation has resulted in rising sales of exhaust- totaling €18.8 million in the Powertrain division. gas sensors in particular. In the Hybrid Electric Vehicle business unit, sales volumes for power electronics, on-board power supply In addition, the reversal of restructuring provisions no longer re- and battery systems were up year-on-year. Owing to program quired resulted in income totaling €0.7 million, which included €0.2 changeovers, sales figures of the Transmission business unit were million from a reversal of impairment losses on property, plant and down year-on-year in fiscal 2017. Sales volumes in the Fuel & Ex- equipment. haust Management business unit increased in comparison to the previous year. Special effects in 2017 had a negative impact totaling €18.1 mil- lion in the Powertrain division. Sales up 4.7% Sales up 5.6% before changes in the scope of Special effects in 2016 consolidation and exchange-rate effects Impairment and reversal of impairment losses on property, plant Sales in the Powertrain division rose by 4.7% year-on-year to and equipment resulted in expense totaling €7.6 million. €7,660.9 million (PY: €7,319.5 million) in 2017. Before changes in the scope of consolidation and exchange-rate effects, sales rose by In the context of the plant closure in Melbourne, Australia, restruc- 5.6%. turing expenses totaling €1.0 million were incurred in the Power- train division, of which €0.7 million was attributable to impairment Sales € millions on property, plant and equipment.

Additional restructuring expenses and the reversal of restructuring 7,660.9 provisions no longer required resulted in expense of €1.1 million 7,068.5 7,319.5 overall.

The disposal of an equity interest held as a financial asset resulted in income of €1.1 million.

Special effects in 2016 had a negative impact totaling €8.6 million in the Powertrain division.

Procurement 2015 2016 2017 Powertrain’s procurement market was largely stable in 2017. There were occasional problems in the supply of electronic components, but these were solved without affecting customers. Like flat steels, Adjusted EBIT up 18.9% long steels also saw increasing capacity utilization of steel plants The Powertrain division’s adjusted EBIT rose by €75.4 million or with prolonged delivery times. Average prices for precious and in- 18.9% year-on-year in 2017 to €473.5 million (PY: €398.1 million), dustrial metals traded in U.S. dollars were higher than the previous equivalent to 6.2% (PY: 5.4%) of adjusted sales. year’s level. The procurement cooperation with the was again successfully continued.

Research and Development Research and development expenses (net) fell by €2.5 million or 0.4% year-on-year to €699.0 million (PY: €701.5 million), corre- sponding to 9.1% (PY: 9.6%) of sales.

Continental AG 2017 Annual Report Management Report Economic Report 83

Powertrain in € millions 2017 2016 ∆ in % Sales 7,660.9 7,319.5 4.7 EBITDA 854.8 756.2 13.0 in % of sales 11.2 10.3 EBIT 439.9 378.0 16.4 in % of sales 5.7 5.2 Research and development expenses (net) 699.0 701.5 –0.4 in % of sales 9.1 9.6 Depreciation and amortization1 414.9 378.2 9.7

thereof impairment2 18.6 8.3 Operating assets as at December 31 3,400.8 3,225.2 5.4 Operating assets (average) 3,325.6 3,015.8 10.3

ROCE 13.2 12.5 Capital expenditure3 653.7 544.4 20.1 in % of sales 8.5 7.4 Number of employees as at December 314 40,492 37,502 8.0

Adjusted sales5 7,652.9 7,319.5 4.6 Adjusted operating result (adjusted EBIT)6 473.5 398.1 18.9 in % of adjusted sales 6.2 5.4

1 Excluding impairment on financial investments. 2 Impairment also includes necessary reversal of impairment losses. 3 Capital expenditure on property, plant and equipment, and software. 4 Excluding trainees. 5 Before changes in the scope of consolidation. 6 Before amortization of intangible assets from purchase price allocation (PPA), changes in the scope of consolidation, and special effects.

Depreciation and amortization While exchange-rate effects increased the Powertrain division’s total Depreciation and amortization rose by €36.7 million compared to operating assets by €10.0 million in the previous year, they reduced fiscal 2016 to €414.9 million (PY: €378.2 million) and amounted to them by €97.6 million in the year under review. 5.4% (PY: 5.2%) of sales. This included impairment totaling €18.6 million in 2017 (PY: €8.3 million). Average operating assets in the Powertrain division climbed by €309.8 million to €3,325.6 million as compared to fiscal 2016 Operating assets (€3,015.8 million). Operating assets in the Powertrain division increased by €175.6 million year-on-year to €3,400.8 million (PY: €3,225.2 million) as at Capital expenditure (additions) December 31, 2017. Additions to the Powertrain division increased by €109.3 million year-on-year to €653.7 million (PY: €544.4 million). Capital expendi- Working capital increased by €40.0 million to €372.6 million (PY: ture amounted to 8.5% (PY: 7.4%) of sales. €332.6 million). Inventories increased by €26.9 million to €470.4 million (PY: €443.5 million). Operating receivables rose by €61.2 In the Powertrain division, production capacity was increased at million to €1,355.3 million (PY: €1,294.1 million) as at the reporting German locations and in China, the U.S.A., Czechia and Romania. date. Total operating liabilities were up €48.1 million at €1,453.1 Important additions related to the Engine Systems and Sensors & million (PY: €1,405.0 million). Actuators business units. In the Engine Systems business unit, man- ufacturing capacity for engine injection systems was expanded. Non-current operating assets were up €205.5 million year-on-year at €3,454.6 million (PY: €3,249.1 million). Goodwill decreased by Employees €18.5 million to €986.3 million (PY: €1,004.8 million) as a result of The number of employees in the Powertrain division rose by 2,990 exchange-rate effects. At €2,188.8 million, property, plant and compared with the previous year to 40,492 (PY: 37,502). The in- equipment was €195.8 million above the previous year’s level of crease in the workforce resulted from the adjustment in line with €1,993.0 million. Other intangible assets climbed by €22.6 million higher sales volumes and the continual expansion in research and to €178.0 million (PY: €155.4 million). Amortization of intangible development. assets from purchase price allocation (PPA) in the amount of €11.9 million (PY: €11.5 million) reduced the value of intangible assets.

84 Continental AG 2017 Annual Report Management Report Economic Report

Development of the Interior Division EBIT up 31.9% In comparison to the previous year, the Interior division posted an increase in EBIT of €181.4 million, or 31.9%, to €749.2 million (PY: › Sales up 11.8% €567.8 million) in 2017. The return on sales rose to 8.1% (PY: 6.8%). › Sales up 11.6% before changes in the scope of It should be noted that several isolated events had a negative im- consolidation and exchange-rate effects pact on the result in the third quarter of the previous year. › Adjusted EBIT up 34.4% The amortization of intangible assets from purchase price alloca- tion (PPA) reduced EBIT by €46.1 million (PY: €38.4 million). Sales volumes Sales volumes in the Body & Security business unit were signifi- ROCE amounted to 14.9% (PY: 12.6%). cantly above the previous year’s level in fiscal 2017. There were increases in Asia and Europe in particular. In the Infotainment & Special effects in 2017 Connectivity business unit, sales figures slightly exceeded the pre- In the Interior division, goodwill totaling €23.0 million that arose in vious year’s figure. This was chiefly due to higher demand and new connection with the expansion of our mobility-services activities products that went into production in the connectivity and multi- was impaired, outside the scope of the annual impairment test. media areas. Sales volumes in the Commercial Vehicles & Aftermar- ket business unit were above the previous year’s level overall. This The reversal of restructuring provisions no longer required resulted is essentially attributable to the stronger market for commercial ve- in income totaling €5.4 million in the Interior division, which in- hicles in Western Europe and North America and to rising demand cluded €4.8 million from a reversal of impairment losses on prop- in the replacement parts and aftermarket business, especially for erty, plant and equipment. brakes and diesel pumps in Europe. In the Instrumentation & Driver HMI business unit, sales volumes in 2017 were higher than in the In addition, the acquisition of the remaining shares in a joint ven- previous year. This increase is generally attributable to the sales ture resulted in income of €1.9 million in the Interior division from development in the European market and particularly to the in- the adjustment of the market value of the previously held shares. creased demand for display solutions and head-up displays. Special effects in 2017 had a negative impact totaling €15.7 mil- Sales up 11.8% lion in the Interior division. Sales up 11.6% before changes in the scope of consolidation and exchange-rate effects Special effects in 2016 In 2017, sales in the Interior division rose by 11.8% year-on-year to In the context of the plant closure in Melbourne, Australia, restruc- €9,305.2 million (PY: €8,324.7 million). Before changes in the scope turing expenses totaling €22.1 million were incurred in the Interior of consolidation and exchange-rate effects, sales rose by 11.6%. division, of which €8.5 million was attributable to impairment on property, plant and equipment. Sales € millions The planned closure of the location in Gravataí, Brazil, resulted in restructuring expenses totaling €4.4 million. This included impair- 9,305.2 ment on property, plant and equipment in the amount of €3.1 mil- 8,154.8 8,324.7 lion.

The reversal of restructuring provisions no longer required resulted in income of €0.1 million.

A purchase price adjustment resulted in expense of €0.1 million.

Special effects in 2016 had a negative impact totaling €26.5 mil- lion in the Interior division. 2015 2016 2017

Adjusted EBIT up 34.4% The Interior division’s adjusted EBIT increased by €217.8 million or 34.4% year-on-year in 2017 to €850.5 million (PY: €632.7 million), equivalent to 9.2% (PY: 7.6%) of adjusted sales. It should be noted that several isolated events had a negative impact on the result in the third quarter of previous year.

Continental AG 2017 Annual Report Management Report Economic Report 85

Interior in € millions 2017 2016 ∆ in % Sales 9,305.2 8,324.7 11.8 EBITDA 1,140.0 904.2 26.1 in % of sales 12.3 10.9 EBIT 749.2 567.8 31.9 in % of sales 8.1 6.8 Research and development expenses (net) 1,062.7 956.0 11.2 in % of sales 11.4 11.5 Depreciation and amortization1 390.8 336.4 16.2

thereof impairment2 18.2 11.6 Operating assets as at December 31 5,240.8 4,758.9 10.1 Operating assets (average) 5,028.9 4,513.8 11.4

ROCE 14.9 12.6 Capital expenditure3 453.3 428.9 5.7 in % of sales 4.9 5.2 Number of employees as at December 314 46,006 43,344 6.1

Adjusted sales5 9,234.3 8,324.7 10.9 Adjusted operating result (adjusted EBIT)6 850.5 632.7 34.4 in % of adjusted sales 9.2 7.6

1 Excluding impairment on financial investments. 2 Impairment also includes necessary reversal of impairment losses. 3 Capital expenditure on property, plant and equipment, and software. 4 Excluding trainees. 5 Before changes in the scope of consolidation. 6 Before amortization of intangible assets from purchase price allocation (PPA), changes in the scope of consolidation, and special effects.

Procurement Operating assets For Interior, the year 2017 was dominated by supply problems as a Operating assets in the Interior division increased by €481.9 mil- result of earthquakes in the Kumamoto region of Japan in the pre- lion year-on-year to €5,240.8 million (PY: €4,758.9 million) as at vious year. Demand for microcontrollers from a Japanese supplier December 31, 2017. could only be covered at great expense. There were also supply problems for electronic components, which resulted in increased Working capital increased by €92.9 million to €778.9 million (PY: costs in the supply chain. In the interests of active risk manage- €686.0 million). Inventories increased by €60.7 million to €823.7 ment, the process of nominating alternative supply options for key million (PY: €763.0 million). Operating receivables rose by €152.1 components was further advanced. The share of displays in total million to €1,595.9 million (PY: €1,443.8 million) as at the reporting procurement volumes for the Interior division and the size of the date. Operating liabilities were up €119.9 million at €1,640.7 mil- displays have both increased further. lion (PY: €1,520.8 million).

Research and development Non-current operating assets were up €373.9 million year-on-year Research and development expenses (net) rose by €106.7 million at €5,076.4 million (PY: €4,702.5 million). Goodwill increased by or 11.2% year-on-year to €1,062.7 million (PY: €956.0 million), cor- €138.9 million to €2,701.4 million (PY: €2,562.5 million). The in- responding to 11.4% (PY: 11.5%) of sales. crease resulted primarily from the acquisition of Argus Cyber Secu- rity Ltd, Tel Aviv, Israel, amounting to €177.5 million and two share Depreciation and amortization deals totaling €23.4 million, which were countered by a purchase Depreciation and amortization rose by €54.4 million compared to price adjustment of €0.7 million, exchange-rate effects of €38.3 fiscal 2016 to €390.8 million (PY: €336.4 million) and amounted to million and allowances of €23.0 million. At €1,519.0 million, prop- 4.2% (PY: 4.0%) of sales. This included impairment totaling €18.2 erty, plant and equipment was €124.6 million above the previous million in 2017 (PY: €11.6 million). year’s level of €1,394.4 million. Other intangible assets climbed by

86 Continental AG 2017 Annual Report Management Report Economic Report

€93.0 million to €684.8 million (PY: €591.8 million). This increase Capital expenditure (additions) was due mainly to the acquisition of Argus Cyber Security Ltd, Tel Additions to the Interior division rose by €24.4 million year-on- Aviv, Israel, which accounted for €179.5 million. This was countered year to €453.3 million (PY: €428.9 million). Capital expenditure by exchange-rate effects of €26.2 million and amortization of intan- amounted to 4.9% (PY: 5.2%) of sales. gible assets from purchase price allocation (PPA) in the amount of €46.1 million (PY: €38.4 million). In addition to the expansion of production capacity at German loca- tions, investments were also made in China, Czechia, Mexico, Roma- Overall, the acquisition of Argus Cyber Security Ltd, Tel Aviv, Israel, nia and the U.S.A. Investments focused primarily on the expansion at €353.4 million and two share deals totaling €32.4 million re- of manufacturing capacity for the Instrumentation & Driver HMI and sulted in an increase in operating assets. The value was reduced by Body & Security business units. In the Instrumentation & Driver a purchase price adjustment of €0.7 million. Other changes in the HMI business unit, manufacturing capacity for operation and dis- scope of consolidation did not result in any additions or disposals play solutions was expanded. of operating assets. Employees While exchange-rate effects increased the Interior division’s total The number of employees in the Interior division rose by 2,662 to operating assets by €25.9 million in the previous year, they re- 46,006 (PY: 43,344). The rise in staff numbers is due to the contin- duced them by €131.8 million in the year under review. uing expansion in research and development and the adjustment in line with greater volumes. The increase related to the Body & Secu- Average operating assets in the Interior division climbed by €515.1 rity, Commercial Vehicles & Aftermarket, Instrumentation & Driver million to €5,028.9 million as compared to fiscal 2016 (€4,513.8 HMI, and Intelligent Transportation Systems business units, while million). Infotainment & Connectivity remained at the previous year’s level.

Continental AG 2017 Annual Report Management Report Economic Report 87

Rubber Group

Rubber Group in € millions 2017 2016 ∆ in % Sales 17,494.7 16,097.6 8.7 EBITDA 3,499.6 3,559.6 –1.7 in % of sales 20.0 22.1 EBIT 2,593.5 2,688.6 –3.5 in % of sales 14.8 16.7 Research and development expenses (net) 428.2 380.6 12.5 in % of sales 2.4 2.4 Depreciation and amortization1 906.1 871.0 4.0

thereof impairment2 2.9 37.2 Operating assets as at December 31 9,073.6 8,640.4 5.0 Operating assets (average) 9,325.1 8,561.4 8.9

ROCE 27.8 31.4 Capital expenditure3 1,060.2 1,094.1 –3.1 in % of sales 6.1 6.8 Number of employees as at December 314 100,749 94,966 6.1

Adjusted sales5 16,965.4 16,093.3 5.4 Adjusted operating result (adjusted EBIT)6 2,643.6 2,815.8 –6.1 in % of adjusted sales 15.6 17.5

1 Excluding impairment on financial investments. 2 Impairment also includes necessary reversal of impairment losses. 3 Capital expenditure on property, plant and equipment, and software. 4 Excluding trainees. 5 Before changes in the scope of consolidation. 6 Before amortization of intangible assets from purchase price allocation (PPA), changes in the scope of consolidation, and special effects.

The Rubber Group comprises two divisions: In the year under review, the 15 business units in total generated 40% of consolidated sales. › The Tire division (26% of consolidated sales) is known for maxi- mizing safety through short braking distances and excellent grip The Rubber Group was confronted with considerably increased as well as reducing fuel consumption by minimizing rolling resist- raw materials prices in 2017. For example, natural rubber and buta- ance. diene, an input material for synthetic rubber, reached their highest price levels in recent years in the first quarter of 2017. In particular, › The ContiTech division (14% of consolidated sales) develops, primary products for rubber compounds posted notably higher manufactures and markets functional parts, intelligent compo- price in this period. nents and systems made of rubber, plastic, metal and fabric for machine and plant engineering, mining, agriculture, the auto- motive industry, and for other important sectors.

88 Continental AG 2017 Annual Report Management Report Economic Report

Development of the Tire Division Special effects in 2017 In the Tire division, the disposal of equity interests held as financial assets resulted in income totaling €14.0 million. › Sales up 5.7% › Sales up 5.3% before changes in the scope of In addition, a first-time consolidation resulted in a gain of €0.5 consolidation and exchange-rate effects million. › Adjusted EBIT down 7.3% Moreover, the reversal of restructuring provisions no longer re- quired resulted in income of €10.0 million. Sales volumes In 2017, sales figures for passenger and light truck tires were at Impairment on property, plant and equipment resulted in expense the previous year’s level in original-equipment business, while sales totaling €0.5 million in the Tire division. volumes in the tire-replacement business were up 4% year-on-year. Sales figures in commercial-vehicle tire business were 5% higher Special effects in 2017 had a positive impact totaling €24.0 million than in the previous year as well. The Tire division therefore sold in the Tire division. around 155 million tires in 2017. Special effects in 2016 Sales up 5.7% The disposal of an equity interest held as a financial asset resulted Sales up 5.3% before changes in the scope of in income of €3.9 million. consolidation and exchange-rate effects Sales in the Tire division rose by 5.7% year-on-year to €11,325.8 Impairment on property, plant and equipment resulted in expense million (PY: €10,717.4 million) in 2017. Before changes in the totaling €0.2 million. scope of consolidation and exchange-rate effects, sales rose by 5.3%. Special effects in 2016 had a positive impact totaling €3.7 million in the Tire division. Sales € millions Procurement The prices for natural rubber and important oil-based raw materials 11,325.8 10,408.8 10,717.4 reached a high in the first half of 2017. In particular, the prices of input materials such as butadiene and of raw materials such as nat- ural rubber were very volatile because of both increased demand and speculation. For example, these prices rose sharply in the first quarter of 2017, reaching the highest value of recent years. In the subsequent quarter, prices for rubber were quoted much lower again. The second half of the year was characterized by substan- tially reduced volatility. On average, the price level in 2017 as a whole was much higher than in the previous year.

2015 2016 2017 Research and development Research and development expenses (net) rose by €28.9 million or 11.1% year-on-year to €289.8 million (PY: €260.9 million), corre- Adjusted EBIT down 7.3% sponding to 2.6% (PY: 2.4%) of sales. The Tire division’s adjusted EBIT fell by €168.4 million or 7.3% year- on-year in 2017 to €2,128.2 million (PY: €2,296.6 million), equiva- Depreciation and amortization lent to 19.0% (PY: 21.4%) of adjusted sales. Depreciation and amortization rose by €58.1 million compared to fiscal 2016 to €597.4 million (PY: €539.3 million) and amounted to EBIT down 6.0% 5.3% (PY: 5.0%) of sales. This included impairment totaling €0.5 mil- In comparison to the previous year, the Tire division posted a de- lion in 2017 (PY: €0.2 million). cline in EBIT of €138.1 million, or 6.0%, to €2,151.3 million (PY: €2,289.4 million) in 2017. The return on sales fell to 19.0% (PY: 21.4%).

The amortization of intangible assets from purchase price alloca- tion (PPA) reduced EBIT by €19.5 million (PY: €10.7 million).

ROCE amounted to 35.0% (PY: 40.8%).

Continental AG 2017 Annual Report Management Report Economic Report 89

Tires in € millions 2017 2016 ∆ in % Sales 11,325.8 10,717.4 5.7 EBITDA 2,748.7 2,828.7 –2.8 in % of sales 24.3 26.4 EBIT 2,151.3 2,289.4 –6.0 in % of sales 19.0 21.4 Research and development expenses (net) 289.8 260.9 11.1 in % of sales 2.6 2.4 Depreciation and amortization1 597.4 539.3 10.8

thereof impairment2 0.5 0.2 Operating assets as at December 31 5,995.7 5,771.9 3.9 Operating assets (average) 6,143.0 5,612.7 9.4

ROCE 35.0 40.8 Capital expenditure3 847.0 882.1 –4.0 in % of sales 7.5 8.2 Number of employees as at December 314 53,811 52,057 3.4

Adjusted sales5 11,194.7 10,716.6 4.5 Adjusted operating result (adjusted EBIT)6 2,128.2 2,296.6 –7.3 in % of adjusted sales 19.0 21.4

1 Excluding impairment on financial investments. 2 Impairment also includes necessary reversal of impairment losses. 3 Capital expenditure on property, plant and equipment, and software. 4 Excluding trainees. 5 Before changes in the scope of consolidation. 6 Before amortization of intangible assets from purchase price allocation (PPA), changes in the scope of consolidation, and special effects.

Operating assets While exchange-rate effects increased the Tire division’s total oper- Operating assets in the Tire division increased by €223.8 million ating assets by €145.9 million in the previous year, they reduced year-on-year to €5,995.7 million (PY: €5,771.9 million) as at them by €353.7 million in the year under review. December 31, 2017. Average operating assets in the Tire division increased by €530.3 The Tire division posted a €138.5 million increase in working capi- million to €6,143.0 million compared with fiscal 2016 (€5,612.7 tal to €2,474.2 million (PY: €2,335.7 million). Inventories increased million). by €177.4 million to €1,608.2 million (PY: €1,430.8 million). Oper- ating receivables increased by €66.3 million to €2,163.2 million Capital expenditure (additions) (PY: €2,096.9 million) as at the reporting date. Operating liabilities Additions to the Tire division decreased by €35.1 million year-on- were up €105.2 million at €1,297.2 million (PY: €1,192.0 million). year to €847.0 million (PY: €882.1 million). Capital expenditure amounted to 7.5% (PY: 8.2%) of sales. Non-current operating assets were up €74.2 million year-on-year at €4,492.8 million (PY: €4,418.6 million). This increase was due In the Tire division, production capacity was expanded in Europe, primarily to the €78.7 million rise in property, plant and equipment North America and Asia. There were major additions relating to the to €4,023.4 million (PY: €3,944.7 million). Goodwill had a contrary expansion of existing production sites in Hefei, China; Mount Vernon, effect and decreased by €2.0 million to €205.2 million (PY: €207.2 Illinois and Sumter, South Carolina, U.S.A.; Púchov, Slovakia; and million). This decrease is attributable to exchange-rate effects of Lousado, Portugal. Investments were also made in the new plant €5.1 million and a contrary purchase price adjustment of €3.1 mil- buildings in Rayong, Thailand, and Clinton, Mississippi, U.S.A. In ad- lion. Other intangible assets declined by €17.0 million to €129.3 dition, quality assurance and cost-cutting measures were imple- million (PY: €146.3 million). Amortization of intangible assets from mented. purchase price allocation (PPA) in the amount of €19.5 million (PY: €10.7 million) reduced the value of intangible assets.

In connection with several asset deals and a purchase price adjust- ment, operating assets rose by €5.7 million overall. Other changes in the scope of consolidation did not result in any notable additions or disposals of operating assets.

90 Continental AG 2017 Annual Report Management Report Economic Report

Employees addition, the increase in the number of employees was attributable The number of employees in the Tire division increased by 1,754 to expansion projects with regard to distribution and retail compa- to 53,811 (PY: 52,057). At the production companies, the ongoing nies, especially as a result of the acquisition of Vaysse S.A.S., France, expansion of the plants in Lousado, Portugal; Otrokovice, Czechia; and the expansion of research and development activities world- Púchov, Slovakia; Hefei, China; and Sumter, South Carolina and wide. Mount Vernon, Illinois, U.S.A., led to an increase in staff numbers. In

Continental AG 2017 Annual Report Management Report Economic Report 91

Development of the ContiTech Division Special effects in 2017 Impairment on property, plant and equipment resulted in expense totaling €2.4 million in the ContiTech division. › Sales up 14.4% › Sales up 8.1% before changes in the scope of In addition, restructuring expenses and the reversal of restructuring consolidation and exchange-rate effects provisions no longer required resulted in income of €0.2 million › Adjusted EBIT down 0.7% overall.

In the ContiTech division, disposals of companies and assets Sales up 14.4% resulted in an expense totaling €1.6 million. Sales up 8.1% before changes in the scope of consolidation and exchange-rate effects Special effects in 2017 had a negative impact totaling €3.8 million Sales in the ContiTech division rose by 14.4% year-on-year to in the ContiTech division. €6,246.4 million (PY: €5,462.5 million) in 2017. Before changes in the scope of consolidation and exchange-rate effects, sales rose by Special effects in 2016 8.1%. Sales grew strongly in the industrial business, due in particu- Due to the market situation in 2016, impairment totaling €33.1 lar to increased demand in the mining and oil production business. million on intangible assets was recognized for the Conveyor Belt In addition, sales in both automotive original equipment and the Group and Industrial Fluid Solutions business units. replacement business increased significantly in comparison to the previous year. A subsequent purchase price adjustment in connection with the acquisition of Veyance Technologies resulted in income totaling Sales € millions €27.0 million.

A further purchase price adjustment resulted in expense of €0.9 6,246.4 million. 5,367.8 5,462.5 The sale of the steel cord business in Brazil, coupled with the fulfillment of conditions imposed by antitrust authorities, resulted in expense totaling €15.9 million. This figure comprises a loss on disposal of €9.3 million, market value adjustments totaling €6.0 million, and sales tax receivables that can no longer be utilized in the amount of €0.6 million.

The temporary cessation of conveyor belt production in Volos, 2015 2016 2017 Greece, resulted in restructuring expenses of €11.2 million, of which €3.4 million was attributable to impairment on property, plant and equipment. Adjusted EBIT down 0.7% The ContiTech division’s adjusted EBIT was down by €3.8 million or Restructuring expenses of €3.1 million were incurred in Chile, 0.7% year-on-year in 2017 to €515.4 million (PY: €519.2 million), including impairment on property, plant and equipment in the equivalent to 8.8% (PY: 9.5%) of adjusted sales. amount of €0.9 million.

EBIT up 10.8% Additional restructuring expenses and the reversal of restructuring In comparison to the previous year, the ContiTech division posted provisions no longer required resulted in expense of €0.2 million an increase in EBIT of €43.0 million, or 10.8%, to €442.2 million overall. This included reversal of impairment losses on property, (PY: €399.2 million) in 2017. The return on sales fell to 7.1% (PY: plant and equipment in the amount of €0.4 million. 7.3%). Impairment and a reversal of an impairment loss on property, plant The amortization of intangible assets from purchase price alloca- and equipment did not result in any effect on earnings overall. tion (PPA) reduced EBIT by €93.2 million (PY: €82.7 million). Special effects in 2016 had a negative impact totaling €37.4 ROCE amounted to 13.9% (PY: 13.5%). million in the ContiTech division.

92 Continental AG 2017 Annual Report Management Report Economic Report

ContiTech in € millions 2017 2016 ∆ in % Sales 6,246.4 5,462.5 14.4 EBITDA 750.9 730.9 2.7 in % of sales 12.0 13.4 EBIT 442.2 399.2 10.8 in % of sales 7.1 7.3 Research and development expenses (net) 138.4 119.7 15.6 in % of sales 2.2 2.2 Depreciation and amortization1 308.7 331.7 –6.9

thereof impairment2 2.4 37.0 Operating assets as at December 31 3,077.9 2,868.5 7.3 Operating assets (average) 3,182.1 2,948.7 7.9

ROCE 13.9 13.5 Capital expenditure3 213.2 212.0 0.6 in % of sales 3.4 3.9 Number of employees as at December 314 46,938 42,909 9.4

Adjusted sales5 5,848.2 5,459.0 7.1 Adjusted operating result (adjusted EBIT)6 515.4 519.2 –0.7 in % of adjusted sales 8.8 9.5

1 Excluding impairment on financial investments. 2 Impairment also includes necessary reversal of impairment losses. 3 Capital expenditure on property, plant and equipment, and software. 4 Excluding trainees. 5 Before changes in the scope of consolidation. 6 Before amortization of intangible assets from purchase price allocation (PPA), changes in the scope of consolidation, and special effects.

Procurement Working capital was up €118.3 million at €1,021.8 million (PY: As a result of rising demand on the raw materials markets, the Conti- €903.5 million). Inventories increased by €90.0 million to €720.1 Tech division registered increasing prices for many raw materials in million (PY: €630.1 million). Operating receivables rose by €114.3 a very volatile environment. In particular, rubber and carbon black million to €1,061.1 million (PY: €946.8 million) as at the reporting prices were up significantly year-on-year. In the first quarter of 2017, date. Operating liabilities were up €86.0 million at €759.4 million prices for rubber and the input material butadiene, driven by spec- (PY: €673.4 million). ulation, climbed to their highest level in years. The higher crude oil prices year-on-year resulted in increased carbon black prices. Prices Non-current operating assets were up €143.4 million year-on-year for rubber sank appreciably in the second half of the year. at €2,439.3 million (PY: €2,295.9 million). Goodwill increased by €61.2 million to €486.5 million (PY: €425.3 million). €91.8 million Research and development of this increase resulted from the acquisition of the Hornschuch Expenses for research and development (net) rose by €18.7 million Group and €4.0 million from a share deal, which were countered by or 15.6% year-on-year to €138.4 million (PY: €119.7 million), corre- exchange-rate effects of €34.6 million. At €1,388.6 million, prop- sponding to 2.2% of sales as in the previous year. erty, plant and equipment was €57.8 million above the previous year’s level of €1,330.8 million. Intangible assets climbed by €16.4 Depreciation and amortization million to €532.8 million (PY: €516.4 million). This includes the ac- Depreciation and amortization declined by €23.0 million compared quisition of the Hornschuch Group, which accounts for €163.3 mil- to fiscal 2016 to €308.7 million (PY: €331.7 million) and amounted lion, while the value was reduced by exchange-rate effects of €54.5 to 4.9% (PY: 6.1%) of sales. This included impairment totaling €2.4 million. Amortization of intangible assets from purchase price allo- million in 2017 (PY: €37.0 million). cation (PPA) in the amount of €93.2 million (PY: €82.7 million) re- duced the value of intangible assets. Operating assets Operating assets in the ContiTech division increased by €209.4 The acquisition of the Hornschuch Group and a share deal at million year-on-year to €3,077.9 million (PY: €2,868.5 million) as €463.0 million and €14.9 million contributed to an increase in the at December 31, 2017. ContiTech division’s operating assets. Other changes in the scope of consolidation did not result in any notable additions or disposals of operating assets.

Continental AG 2017 Annual Report Management Report Economic Report 93

While exchange-rate effects increased the ContiTech division’s total Employees operating assets by €30.8 million in the previous year, they reduced The number of employees in the ContiTech division increased by them by €196.4 million in the year under review. 4,029 compared with the previous year to 46,938 (PY: 42,909). This increase in the workforce was due chiefly to higher volumes in Average operating assets in the ContiTech division climbed by the Mobile Fluid Systems and Benecke-Hornschuch Surface Group €233.4 million to €3,182.1 million as compared to fiscal 2016 (formerly Benecke-Kaliko Group) business units. The increase in the (€2,948.7 million). number of employees is also due to the acquisition of the Hornschuch Group. Capital expenditure (additions) Additions to the ContiTech division increased by €1.2 million year- on-year to €213.2 million (PY: €212.0 million). Capital expenditure amounted to 3.4% (PY: 3.9%) of sales.

In the ContiTech division, the production facilities at German loca- tions and in China, the U.S.A., Mexico and Hungary were expanded and established. Production capacity for the Mobile Fluid Systems, Benecke-Hornschuch Surface Group (formerly Benecke-Kaliko Group), Power Transmission Group, and Conveyor Belt Group busi- ness units was expanded in particular. Investments were made in all business units to rationalize existing production processes.

94 Continental AG 2017 Annual Report Management Report Continental AG

Continental AG Short Version in acc. with HGB

In addition to the reporting on the corpora- Total assets decreased by €264.5 million year-on-year to €18,801.5 million (PY: €19,066.0 million). On the assets side, the tion as a whole, the performance of the par- change is due primarily to the €322.0 million decline in cash and ent company is presented separately below. cash equivalents. This was countered by a €74.5 million increase in receivables from affiliated companies to €7,442.5 million (PY: €7,368.0 million). Unlike the consolidated financial statements, the annual financial statements of Continental AG are prepared in accordance with Investments increased by €4.7 million year-on-year to €10,995.4 German commercial law (the German Commercial Code, Handels- million (PY: €10,990.7 million) and now account for 58.5% of total gesetzbuch – HGB) and the German Stock Corporation Act (Aktien- assets after 57.6% in the previous year. The increase resulted pri- gesetz – AktG). The management report of Continental AG has been marily from the addition of investment securities. combined with the consolidated report of the Continental Corpora- tion in accordance with Section 315 (5) HGB, as the parent com- At €28.6 million (PY: €31.2 million), prepaid expenses and deferred pany’s future risks and opportunities and its expected development charges were down €2.6 million. The decline resulted from the are inextricably linked to that of the corporation as a whole. In addi- straight-line reversal of prepaid expenses for the syndicated loan tion, the following presentation of the parent company’s business and from the reduction of other prepaid expenses. performance, including its results, net assets and financial position, provides a basis for understanding the Executive Board’s proposal On the equity and liabilities side, liabilities to affiliated companies for the distribution of net income. decreased by €575.5 million year-on-year to €9,208.1 million (PY: €9,783.6 million). Bank loans and overdrafts also declined by Continental AG acts solely as a management and holding company €257.5 million to €214.0 million (PY: €471.5 million) and trade ac- for the Continental Corporation. counts payable by €7.5 million to €25.5 million (PY: €33.0 million).

Net assets and financial position of Continental AG Dec. 31, 2017 Dec. 31, 2016 Assets in € millions Intangible assets 26.4 40.2 Property, plant and equipment 6.8 3.2 Investments 10,995.4 10,990.7

Non-current assets 11,028.6 11,034.1 Inventories 0.0 0.0 Receivables and other assets 7,487.1 7,421.5 Cash and cash equivalents 257.2 579.2

Current assets 7,744.3 8,000.7 Prepaid expenses and deferred charges 28.6 31.2 Total assets 18,801.5 19,066.0

Shareholders’ equity and liabilities in € millions Subscribed capital 512.0 512.0 Capital reserves 4,179.1 4,179.1 Revenue reserves 54.7 54.7 Accumulated profits brought forward from the previous year 253.1 264.1 Net income 1,217.3 839.0

Shareholders’ equity 6,216.2 5,848.9 Provisions 963.1 755.6 Liabilities 11,622.2 12,461.5 Total equity and liabilities 18,801.5 19,066.0

Gearing ratio in % 65.1 78.4 Equity ratio in % 33.1 30.7

Continental AG 2017 Annual Report Management Report Continental AG 95

Provisions increased by €207.5 million to €963.1 million (PY: The negative net interest result improved by €10.1 million year-on- €755.6 million) due to the increase in tax provisions of €181.1 mil- year to €85.6 million in fiscal 2017 (PY: €95.7 million). Interest ex- lion to €697.0 million (PY: €515.9 million) and in pension provi- pense decreased by €15.2 million to €118.3 million (PY: €133.5 sions of €8.8 million to €175.3 million (PY: €166.5 million). Other million), due primarily to the decrease in interest and similar ex- provisions likewise increased by €17.6 million to €90.8 million in pense from affiliated companies. the year under review. Interest income declined by €5.1 million year-on-year to €32.7 mil- Equity increased from €5,848.9 million in the previous year to lion (PY: €37.8 million). Interest and similar income from affiliated €6,216.2 million. The decrease as a result of the dividend payment companies accounted for €1.3 million and interest and similar in- for 2016 in the amount of €850.0 million was offset by the net in- come from other companies €3.8 million. come of €1,217.3 million generated in fiscal 2017. As a result of the increase in equity and the decrease in total assets, the equity The tax expense of €265.6 million (PY: €67.2 million) resulted pri- ratio climbed from 30.7% to 33.1%. marily from current expenses in Germany, from expense for previ- ous years as a result of tax audits and from non-imputable foreign Sales increased by €36.7 million to €237.7 million (PY: €201.0 mil- withholding tax. lion), primarily due to the increase in sales from corporate services of €36.1 million. After taking this tax expense into account, Continental AG posted net income for the year of €1,217.3 million (PY: €839.0 million). Net investment income increased by €607.6 million year-on-year The after-tax return on equity was 19.6% (PY: 14.3%). to €1,737.1 million (PY: €1,129.5 million). As in the previous year, it mainly consisted of profit and loss transfers from the subsidiaries. Taking into account the accumulated profits brought forward from The income from profit transfers resulted particularly from Conti- the previous year of €253.1 million, retained earnings amounted nental Caoutchouc-Export-GmbH, Hanover, in the amount of to €1,470.4 million. The Supervisory Board and the Executive €989.0 million; Continental Automotive GmbH, Hanover, in the Board will propose to the Annual Shareholders’ Meeting the distri- amount of €560.9 million; and Formpolster GmbH, Hanover, in bution of a dividend of €4.50 per share. With 200,005,983 shares the amount of €196.5 million. This was countered by expenses of entitled to dividends, the total distribution will thus amount to €36.0 million from absorbing the loss of UMG Beteiligungsgesell- €900,026,923.50. The remaining amount is to be carried forward schaft mbH, Hanover. to new account.

We expect stable income from profit and loss transfers and invest- ment income from the subsidiaries in fiscal 2018.

Earnings position of Continental AG in € millions 2017 2016 Sales 237.7 201.0 Cost of sales –230.9 –194.8

Gross margin on sales 6.8 6.2 General administrative expenses –182.3 –144.5 Other operating income 35.8 36.9 Other operating expenses –39.2 –36.6 Net investment income 1,737.1 1,129.5 Income from other securities and long-term loans 10.3 10.4 Net interest result –85.6 –95.7

Result from activities 1,482.9 906.2 Income tax expense –265.6 –67.2

Net income 1,217.3 839.0 Accumulated profits brought forward from the previous year 253.1 264.1

Retained earnings 1,470.4 1,103.1

96 Continental AG 2017 Annual Report Management Report Other Information

Other Information Dependent Company Report

Final declaration from the Executive Board’s report on “We declare that the company received an appropriate considera- relations with affiliated companies pursuant to Section 312 of tion for each transaction and measure listed in the report on rela- the German Stock Corporation Act (Aktiengesetz – AktG) tions with affiliated companies from January 1 to December 31, In fiscal 2017, Continental AG was a dependent company of INA- 2017, under the circumstances known to us at the time the trans- Holding Schaeffler GmbH & Co. KG, Herzogenaurach, Germany, as actions were made or the measures taken or not taken. To the ex- defined under Section 312 AktG. In line with Section 312 (1) AktG, tent the company suffered any detriment thereby, the company the Executive Board of Continental AG has prepared a report on re- was granted the right to an appropriate compensation before the lations with affiliated companies, which contains the following final end of the 2017 fiscal year. The company did not suffer any detri- declaration: ment because of taking or refraining from measures.”

Additional Disclosures and Notes Pursuant to Section 289a and Section 315a HGB

1. Composition of subscribed capital appointment, the so-called Mediation Committee must sub- As of the end of the reporting period, the subscribed capital of mit a nomination to the Supervisory Board for the appoint- the company amounts to €512,015,316.48 and is divided into ment within one month of voting. Other nominations can 200,005,983 no-par-value shares. These shares are, without ex- also be submitted to the Supervisory Board in addition to ception, common shares; different classes of shares have not the Mediation Committee’s nomination. A simple majority been issued and have not been provided for in the Articles of of the votes is sufficient when voting on these nominations Incorporation. Each share bears voting and dividend rights submitted to the Supervisory Board. In the event that voting from the time it is issued. Each share entitles the holder to one results in a tie, a new vote takes place in which the Chair- vote at a Shareholders’ Meeting (Article 20 (1) of the Articles of man of the Supervisory Board has the casting vote in ac- Incorporation). There are no shares with privileges. cordance with Section 31 (4) MitbestG.

2. Shareholdings exceeding 10% of voting rights b) Amendments to the Articles of Incorporation are made by For details of the equity interests exceeding 10% of the voting the Shareholders’ Meeting. In Article 20 (3) of the Articles of rights (reported level of equity interest), please refer to the Incorporation, the Shareholders’ Meeting has exercised the notice in accordance with the German Securities Trading Act option granted in Section 179 (1) Sentence 2 AktG to con- (Wertpapierhandelsgesetz – WpHG) under Note 37 to the fer on the Supervisory Board the power to make amend- consolidated financial statements. ments affecting only the wording of the Articles of Incorpo- ration. 3. Bearers of shares with privileges There are no shares with privileges granting control. In accordance with Article 20 (2) of the Articles of Incorpo- ration, resolutions of the Shareholders’ Meeting to amend 4. Type of voting right control for employee shareholdings the Articles of Incorporation are usually adopted by a sim- The company is not aware of any employees with sharehold- ple majority and, insofar as a capital majority is required, ings not directly exercising control of their voting rights. by a simple majority of the capital represented unless other- wise stipulated by mandatory law or particular provisions 5. Provisions for the appointment and dismissal of members of of the Articles of Incorporation. The law prescribes a man- the Executive Board and for the amendment of the Articles datory majority of three quarters of the share capital repre- of Incorporation sented when resolutions are made, for example, for amend- a) In accordance with the Articles of Incorporation, the Execu- ments to the Articles of Incorporation involving substantial tive Board consists of at least two members; beyond this capital measures, such as resolutions concerning the crea- the number of members of the Executive Board is deter- tion of authorized or contingent capital. mined by the Supervisory Board. Members of the Executive Board are appointed and dismissed in accordance with Sec- tion 84 of the German Stock Corporation Act (Aktiengesetz – AktG) in conjunction with Section 31 of the German Co- determination Act (Mitbestimmungsgesetz – MitbestG). In line with this, the Supervisory Board is responsible for the appointment and dismissal of members of the Executive Board. It passes decisions with a majority of two-thirds of its members. If this majority is not reached in the event of an

Continental AG 2017 Annual Report Management Report Other Information 97

6. Authorizations of the Executive Board, particularly with If a change of control occurs as described in the agree- regard to its options for issuing or withdrawing shares ments above and a contractual partner or bondholder exer- a) The Executive Board can issue new shares only on the cises its respective rights, it is possible that required follow- basis of resolutions by the Shareholders’ Meeting. As at the up financing may not be approved under the existing con- end of the reporting period, the Executive Board has not ditions, which could therefore lead to higher financing been authorized to issue new shares in connection with a costs. capital increase (authorized capital) or to issue convertible bonds, warrant-linked bonds, or other financial instruments c) In 1996, Compagnie Financière SCmA, Granges- that could entitle the bearers to subscribe to new shares. Paccot, Switzerland, and Continental AG founded MC Proj- ects B.V., Maastricht, Netherlands, with each owning 50%. b) The Executive Board may only buy back shares under the Michelin contributed the rights to the Uniroyal brand for Eu- conditions codified in Section 71 AktG. The Shareholders’ rope to the company. MC Projects B.V. licenses these rights Meeting has not authorized the Executive Board to acquire to Continental. According to the agreements, this license treasury shares in line with Section 71 (1) Number 8 AktG. can be terminated without notice if a major competitor in the tire business acquires more than 50% of the voting 7. Material agreements of the company subject to a change of rights of Continental. In this case Michelin also has the right control following a takeover bid and their consequences to acquire a majority in MC Projects B.V. and to have MC The following material agreements are subject to a change of Projects B.V. increase its minority stake in the manufactur- control at Continental AG: ing company of Continental s.r.o. in Otrokovice, Czechia, to 51%. In the case of such a change of control a) As at the reporting date, the agreement concluded on and the exercise of these rights, there could be losses in April 24, 2014, for a syndicated loan originally amounting sales of the Tire division and a reduction in the production to €4.5 billion consists only of a revolving tranche of €3.0 capacity available to it. billion. This agreement grants each creditor the right to ter- minate the agreement prematurely and to demand repay- 8. Compensation agreements of the company with members ment of the loans granted by it if one person or several per- of the Executive Board or employees for the event of a take- sons acting in concert acquire control of Continental AG over bid and subsequent negotiations concerning a continuation of No compensation agreements have been concluded between the loan do not lead to an agreement. The term “control” is the company and the members of the Executive Board or em- defined as the holding of more than 50% of the voting ployees providing for the event of a takeover bid. rights or if Continental AG concludes a domination agree- ment as defined under Section 291 AktG with Continental AG as the company dominated. Remuneration of the Executive Board

b) The two bonds issued by Continental AG in 2013 at a nom- inal amount of €750 million each, the bond issued by an- The total remuneration of the members of the Executive Board other subsidiary of Continental AG, Continental Rubber of comprises a number of remuneration components. Specifically, America, Corp., Wilmington, Delaware, U.S.A., in November these components comprise fixed remuneration, variable remuner- 2015 at a nominal amount totaling €500 million, and the ation elements including components with a long-term incentive bond of €600 million issued by Continental AG in Novem- effect, additional benefits and retirement benefits. Further details in- ber 2016 entitle each bondholder to demand that the re- cluding individual remuneration are specified in the Remuneration spective issuer redeem or acquire the bonds held by the Report contained in the Corporate Governance Report starting on bondholder at a price established in the bond conditions page 24. The Remuneration Report is a part of the Management in the event of a change of control at Continental AG. The Report. bond conditions define a change of control as the sale of all or substantially all of the company’s assets to third parties that are not affiliated with the company, or as one person or several persons acting in concert, pursuant to Section 2 (5) of the German Takeover Act (Wertpapiererwerbs- und Über- nahmegesetz – WpÜG), holding more than 50% of the vot- ing rights in Continental AG by means of acquisition or as a result of a merger or other form of combination with the participation of Continental AG. The holding of voting rights by Schaeffler GmbH (operating as IHO Verwaltungs GmbH following legal restructuring within the corporation in 2015), its legal successors, or its affiliated companies does not constitute a change of control within the meaning of the bond conditions.

98 Continental AG 2017 Annual Report Management Report Other Information

Corporate Governance Declaration Pursuant to Section 289f HGB

The Corporate Governance Declaration pursuant to Section 289f of the German Commercial Code (Handelsgesetzbuch – HGB) is available to our shareholders at www.continental-corporation.com in the Company/Corporate Governance section.

Continental AG 2017 Annual Report Management Report Report on Risks and Opportunities 99

Report on Risks and Opportunities

Continental’s overall risk situation is We define risk as the possibility of internal or external events occur- ring that can have a negative influence on the attainment of our analyzed and managed corporation-wide strategic and operational targets. As a global corporation, Continen- using the risk and opportunity tal is exposed to a number of different risks that could impair busi- ness and, in extreme cases, endanger the company’s existence. We management system. accept manageable risks if the resulting opportunities lead us to ex- pect to achieve sustainable growth in value. We consider growth in The management of the Continental Corporation is geared toward value in terms of the Continental Value Contribution (CVC) system creating added value. For us, this means sustainably increasing the described in the Corporate Management section. value of each individual business unit and the corporation as a whole. We evaluate risks and opportunities responsibly and on an ongoing basis in order to achieve our goal of adding value.

Risk and Opportunity Management and Internal Control System

In order to operate successfully as a company in a complex busi- The effectiveness of the financial reporting internal control system ness sector and to ensure the effectiveness, efficiency and propri- (Financial Reporting ICS) is evaluated in major areas by testing the ety of accounting and compliance with the relevant legal and sub- effectiveness of the reporting units on a quarterly basis. If any weak- legislative regulations, Continental has created a governance sys- nesses are identified, the corporation’s management initiates the tem that encompasses all relevant business processes. The gover- necessary measures. nance system comprises the internal control system, the risk man- agement system and the compliance management system, which As part of our opportunity management activities, we assess mar- is described in detail in the Corporate Governance Declaration on ket and economic analyses and changes in legal requirements (e.g. page 23. The risk management system in turn also includes the with regard to fuel consumption and emission standards, safety early risk identification system in accordance with Section 91 (2) regulations). In addition, we deal with the corresponding effects on of the German Stock Corporation Act (Aktiengesetz – AktG). the automotive sector and other relevant markets, our production factors and the composition and further development of our prod- The Executive Board is responsible for the governance system, uct portfolio. which includes all subsidiaries. The Supervisory Board and the Audit Committee monitor its effectiveness. Governance, risk and compliance (GRC) In the GRC policy adopted by the Executive Board, Continental de- Pursuant to sections 289 (4) and 315 (4) of the German Commer- fines the general conditions for integrated GRC as a key element of cial Code (Handelsgesetzbuch – HGB), the main characteristics of the risk management system, which regulates the identification, as- the internal control and risk management system with respect to sessment, reporting and documentation of risks. In addition, this the accounting process must be described. All parts of the risk man- also further increases corporate-wide risk awareness and establish- agement system and internal control system that could have a ma- es the framework for a uniform risk culture. The GRC Committee terial effect on the annual and consolidated financial statements ensures that this policy is adhered to and implemented. must be included in the reporting. The GRC system incorporates all components of risk reporting and Key elements of the corporation-wide control systems are the clear the examination of the effectiveness of the Financial Reporting ICS. allocation of responsibilities and controls inherent in the system Risks are identified, assessed and reported at the organizational when preparing the financial statements. The two-person rule and level that is also responsible for managing the identified risks. A separation of functions are fundamental principles of this organiza- multi-stage assessment process is used to involve also the higher- tion. In addition, Continental’s management ensures accounting level organizational units. The GRC system thus includes all report- that complies with the requirements of law via guidelines on the ing levels, from the company level to the top corporate level. preparation of financial statements and on accounting, access au- thorizations for IT systems and regulations on the involvement of internal and external specialists.

100 Continental AG 2017 Annual Report Management Report Report on Risks and Opportunities

Risk reporting

Integrated GRC

GRC System

General Risk Compliance Risk Financial Reporting Reporting Management Management ICS Unforeseen Risks

›B usiness-related ›C ompliance risks ›A ccounting-related ›U nforeseen risks risks internal controls

Quality Case Legal Case Compliance Case Management Management Management SWOT Analysis

›Q uality cases ›L egal cases ›C ompliance cases ›S trategic risks › GRC Committee ››Executive Board Audit Committee ›C onsolidates and ›R esponsible for ›M onitors integrated GRC monitors risks integrated GRC ›I s material risks ›D risk appetite ›R ecommends further ›M onitors material risks measures

At the corporate level, the responsibilities of the GRC Committee – categories are all described in the Report on Risks and Opportuni- chaired by the Executive Board member responsible for Finance, ties, provided the potential negative EBIT effect of an individual risk Controlling, Compliance, Law and IT – include identifying which or the sum of risks included in a category exceeds €100 million in risks are significant for the corporation. The GRC Committee regu- the period under consideration or there is a significant negative im- larly informs the Executive Board and the Audit Committee of the pact on the strategic corporate goals. Supervisory Board of the major risks, any weaknesses in the con- trol system and measures taken. Moreover, the auditor of the cor- Local management can utilize various instruments for risk assess- poration is required to report to the Audit Committee of the Super- ment, such as predefined risk categories (e.g. exchange-rate risks, visory Board regarding any major weaknesses in the Financial Re- product-liability risks, legal risks) and assessment criteria, a centrally porting ICS which the auditor identified as part of their audit activi- developed function-specific questionnaire as well as the Financial ties. Reporting ICS’s process and control descriptions. The key controls in business processes (purchase to pay, order to cash, asset man- Risk assessment and reporting agement, HR, IT authorizations and the financial statement closing A period under consideration of one year is always applied when process) are thus tested with respect to their effectiveness. evaluating risks and opportunities. The risks and their effects are assessed primarily according to quantitative criteria and assigned All major subsidiaries carry out a semiannual assessment of busi- to different categories in line with the net principle, i.e. after risk mit- ness-related risks and an annual assessment of compliance risks in igation measures. If a risk cannot be assessed quantitatively, then it the GRC system’s IT-aided risk-management application. Any qual- is assessed qualitatively based on the potential negative effects its ity, legal and compliance cases that have actually occurred are also occurrence would have on achieving strategic corporate goals and taken into account when assessing these risks. The quarterly Finan- based on other qualitative criteria such as the impact on Continen- cial Reporting ICS completes regular GRC reporting. tal’s reputation. Furthermore, the GRC Committee identifies and assesses strategic Significant individual risks for the corporation are identified from all risks, for example as part of a SWOT analysis. Any new material the reported risks based on the probability of occurrence and the risks arising unexpectedly between regular reporting dates have to amount of damage that would be caused in the period under con- be reported immediately and considered by the GRC Committee. sideration. The individual risks that Continental has classified as This also includes risks identified in the audits by corporate func- material and the aggregated risks that have been assigned to risk tions.

Continental AG 2017 Annual Report Management Report Report on Risks and Opportunities 101

In addition to the risk analyses carried out by the reporting units as Risk management part of integrated GRC, audits are also performed by the Corporate The responsible management initiates suitable countermeasures Audit department. Furthermore, the central controlling function an- that are also documented in the GRC system for each risk identified alyzes the key figures provided as part of this reporting process and assessed as material. The GRC Committee monitors and con- at corporation and division level in order to assess the effects of solidates the identified risks and suitable countermeasures at the potential risks. corporation level. It regularly reports to the Executive Board and recommends further measures if needed. The Executive Board dis- Continental has set up a Compliance & Anti-Corruption Hotline to cusses and resolves the measures, and reports to the Supervisory give employees and third parties outside the corporation the op- Board’s Audit Committee. The responsible bodies continually moni- portunity to report violations of legal regulations, its fundamental tor the development of all identified risks and the progress of ac- values, and ethical standards. Information on any kind of potential tions initiated. Regular audits of the risk management process by violations, such as bribery or antitrust behavior, but also accounting Corporate Audit guarantee its efficiency and further development. manipulations, can be reported anonymously, where permissible by law, via the hotline. Tips received by the hotline are examined, pur- sued and dealt with fully by Corporate Audit and the Compliance department, as required, with the assistance of other departments.

Material Risks

The order of the risk categories and individual risks presented Furthermore, in addition to other obligations, this syndicated loan within the four risk groups reflects the current assessment of the agreement also requires Continental to comply with a financial relative risk exposure for Continental and thus provides an indica- covenant. This provides for a maximum leverage ratio (calculated tion of the current significance of these risks. If no quantitative in- from the ratio of Continental’s consolidated net indebtedness to formation on the amount of damage is provided, the assessment is consolidated adjusted EBITDA) of 3.00. carried out on the basis of qualitative criteria. Unless the emphasis is placed on a specific division, then the risks apply to all divisions. Owing to the market and operational risks presented below, it can- not be ruled out that under certain extreme circumstances it may not be possible for Continental to comply with the ratio described Financial Risks previously. If Continental fails in this obligation, the creditors are en- titled to declare the loan and bonds immediately due and payable. The committed volume of the syndicated loan consists of a revolv- Continental is exposed to risks in connection with its financing ing tranche of €3.0 billion (due in April 2021). This had not been agreements and the syndicated loan. utilized as at the end of fiscal 2017. Continental is subject to risks in connection with its financing agree- ments. Risks arise from the bonds that Continental AG or its subsid- The leverage ratio was 0.23 as at December 31, 2017. The finan- iaries issued as part of its Debt Issuance Programme. These financ- cial covenant was complied with at all times. ing agreements contain covenants that could limit Continental’s capacity to take action as well as change-of-control provisions. Continental is exposed to risks associated with changes in currency exchange rates and hedging. In order to finance its current business activities as well as its in- Continental operates worldwide and is therefore exposed to finan- vestments and payment obligations, Continental concluded a syn- cial risks that arise from changes in exchange rates. This could re- dicated loan agreement in April 2014 from which risks may arise. sult in losses if assets denominated in currencies with a falling ex- This loan agreement was last renegotiated in April 2016. Under the change rate lose value and/or liabilities denominated in currencies terms of the syndicated loan agreement, the lenders have the right with a rising exchange rate appreciate. In addition, fluctuations in to demand repayment of the loan in the event of a change of con- exchange rates could intensify or reduce fluctuations in the prices trol at Continental AG. The requirements for and consequences of a of raw materials in euros, as Continental sources a considerable change in control in accordance with the terms of the bonds or the portion of its raw materials in foreign currency. As a result of these syndicated loan agreement are described in detail in the Further factors, fluctuations in exchange rates can influence Continental’s Disclosures and Notes section, pursuant to sections 289a and earnings situation. 315a HGB, on pages 96 and 97. The loans and bonds cited here could also immediately become due and payable if other financing agreements of more than €75.0 million are not repaid on time or are prematurely called for repayment.

102 Continental AG 2017 Annual Report Management Report Report on Risks and Opportunities

External and internal transactions involving the delivery of prod- During the global economic crisis in 2008 and 2009, automotive ucts and services to third parties and companies of the Continental sales and production deteriorated substantially, resulting in a sharp Corporation can result in cash inflows and outflows that are de- decline in demand for Continental’s products among its OEM cus- nominated in currencies other than the functional currency of the tomers. At present, it is not known if the current economic situation respective subsidiary of the Continental Corporation (transaction will persist. If this is not the case, automobile production could fall risk). To the extent that cash outflows of the respective subsidiary again and remain at a low level for an extended period of time. This of the Continental Corporation in any one foreign currency are not would impact Continental’s business and earnings situation, espe- offset by cash flows resulting from operational business in the same cially in Europe, where Continental generated 49% of its sales in currency, the remaining net exchange-rate risk is hedged against 2017. A prolonged weakness in or deterioration of the European on a case-by-case basis using the appropriate derivative instru- automotive market would be likely to adversely affect Continental’s ments, particularly currency forwards, currency swaps and cur- sales and results of operations. Furthermore, Continental’s five larg- rency options with a term of up to 12 months. est OEM customers (Daimler, Fiat-Chrysler, Ford, Renault-Nissan- Mitsubishi and VW) generated approximately 41% of the Continen- Moreover, Continental is exposed to exchange-rate risks arising tal Corporation’s sales in 2017. If one or more of Continental’s OEM from external and internal loan agreements, which result from cash customers is lost or terminates a supply contract prematurely, the inflows and outflows in currencies that are denominated in curren- original investments made by Continental to provide such products cies other than the functional currency of the respective subsidiary or outstanding claims against such customers could be wholly or of the Continental Corporation. These exchange-rate risks are in partially lost. general hedged against by using appropriate derivative instru- ments, particularly currency forwards, currency swaps and cross- The potential trade difficulties that arise from the current political currency interest-rate swaps. Any hedging transactions executed in developments in the European Union (e.g. Brexit) and in North the form of derivative instruments can result in losses. Continental’s America could also negatively impact Continental’s business and net foreign investments are, as a rule, not hedged against exchange- earnings situation. rate fluctuations. In addition, a number of Continental’s consoli- dated companies report their results in currencies other than the Based on a scenario analysis that assumes a 20% decrease in vol- euro, which requires Continental to convert the relevant items into umes in fiscal 2018, and taking account of restructuring measures euros when preparing Continental’s consolidated financial state- required as a result, we anticipate a decline of around 6 percentage ments (translation risk). Translation risks are generally not hedged. points in the EBIT margin and of 3 to 4 percentage points in the adjusted EBIT margin. In order to quantify the possible effects of transaction-related ex- change-rate risks from financial instruments on the earnings posi- Continental operates in a cyclical industry. tion of the Continental Corporation, transaction currencies with a Global production of vehicles and, as a result, sales to OEM custom- significant exchange-rate risk within the next 12 months were ers (from whom Continental currently generates 72% of its sales) identified using a mathematical model based on historical volatility. experience major fluctuations in some cases. They depend, among If the exchange rates of these currencies all develop disadvanta- other things, on general economic conditions, disposable income geously for Continental at the same time, then the hypothetical and household consumer spending and preferences, which can be negative effect on the corporation’s earnings position, calculated affected by a number of factors, including fuel costs as well as the based on a 10% change in the current closing rate, would amount availability and cost of consumer financing. As the volume of auto- to between €200 million and €300 million. motive production fluctuates, the demand for Continental’s prod- ucts also fluctuates, as OEMs generally do not commit to purchas- ing minimum quantities from their suppliers or to fixed prices. It is Risks Related to the Markets in which difficult to predict future developments in the markets Continental Continental Operates serves, which also makes it harder to estimate the requirements for production capacity. As Continental’s business is characterized by high fixed costs, it is thus exposed to the risk that fixed costs are Continental could be exposed to material risks in connection not fully covered in the event of falling demand and the resulting with a global financial and economic crisis. underutilization of its facilities (particularly in the Automotive Group). Continental generates a large percentage (72%) of its sales from Conversely, should the markets in which Continental operates grow automobile manufacturers (original-equipment manufacturers, faster than anticipated, there could be insufficient capacity to meet OEMs). The remainder of Continental’s sales is generated from the customer demand. To reduce the impact of the potential risk result- replacement or industrial markets, mainly in the replacement mar- ing from this dependence on the automotive industry, Continental kets for passenger-car and truck tires, and to a lesser extent in the is strengthening its replacement business and industrial business, non-automotive end markets of the other divisions. including by means of acquisitions.

Continental AG 2017 Annual Report Management Report Report on Risks and Opportunities 103

Continental is reliant on certain markets. As a result of the market trends and technical developments de- In 2017, Continental generated 49% of its total sales in Europe and scribed previously, the vehicle mix sold by Continental’s customers 20% in Germany alone. By comparison, 25% of Continental’s total has shifted considerably in the last few years and may also change sales in 2017 were generated in North America, 22% in Asia, and further in the future. As a technology leader, Continental is reacting 4% in other countries. Therefore, in the event of an economic down- to this development with a balanced and innovative product portfo- turn in Europe, particularly in Germany, for example, Continental’s lio. business and earnings situation could be affected more extensively than that of its competitors’. Furthermore, the automotive and tire Continental is exposed to fluctuations in the prices of raw markets in Europe and North America are largely saturated. Conti- materials and electronic components. nental is therefore seeking to generate more sales in emerging For the divisions of the Automotive Group, higher prices for raw markets, particularly Asia, to mitigate the effects of its strong focus materials and electronic components in particular can result in on Europe and Germany. In the current global economic situation, cost increases. The divisions of the Rubber Group mainly depend adverse changes in the geographical distribution of automotive on the development of oil, natural rubber and synthetic rubber demand could also cause Continental to suffer. The current level prices. The prices for these raw materials and components are ex- of automotive production is driven mainly by solid demand from posed to sometimes considerable fluctuations worldwide. In addi- the European and Asian markets, while demand in North America tion, the cost of certain types of synthetic rubber looks set to in- recently consolidated at a high level and even fell slightly. It is not crease, as stricter environmental requirements will apply for the known if the current development in Europe and Asia will prove plants operated in China, one of the most important countries of sustainable. If demand falls further in North America and is not origin, starting in 2018. This could result in the closure of plants, compensated for by an increase on another regional market, this and thus loss of capacity, which could result in price increases. At could also adversely affect demand for Continental products. To present, Continental does not actively hedge against the risk of minimize these risks, Continental is striving to improve the regional rising prices of electronic components or raw materials by using sales balance, as described in the corporate strategy. derivative instruments. If the company is not able to compensate for the increased costs or to pass them onto customers, the price Continental is exposed to risks associated with the market increases could reduce Continental’s income by €100 million to trends and developments that could affect the vehicle mix €200 million. sold by OEMs. Continental currently generates 72% of its sales from OEMs, mainly in its Automotive Group. Global production of vehicles and, as a re- Risks Related to Continental’s Business sult, business with OEM customers are currently subject to a num- Operations ber of market trends and technical developments that may affect the vehicle mix sold by OEMs. Continental is exposed to risks in connection with its pension › Due to increasingly stringent consumption and emission stand- commitments. ards throughout the industrial world, including the EU and Asia, Continental provides defined benefit pension plans in Germany, car manufacturers are increasingly being forced to develop envi- the U.S.A., the U.K. and certain other countries. As of December 31, ronmentally compatible technologies aimed at lowering fuel con- 2017, the pension obligations amounted to €6,379.7 million. These

sumption as well as CO2 and particulate emissions. These develop- existing obligations are financed predominantly through externally ments have caused a trend toward lower-consumption vehicles. invested pension plan assets. In 2006, Continental established le- The emerging markets are focusing strongly on the small-car gally independent trust funds under contractual trust arrange- segment as their introduction to mobility. ments (CTAs) for the funding of pension obligations of certain subsidiaries in Germany. In 2007, Continental assumed additional › In recent years, the market segment of affordable cars has grown pension trust arrangements in connection with the acquisition of steadily, particularly in emerging markets such as China, India and VDO. As of December 31, 2017, Continental’s net pension Brazil, as well as in Eastern Europe. obligations (defined benefit obligations less the fair value of plan assets) amounted to €3,830.6 million. › Over the past decade, hybrid electric vehicles, which combine a conventional internal-combustion-engine drive system with an Continental’s externally invested plan assets are funded by exter- electric drive system, have become increasingly popular. Their nally managed funds and insurance companies. While Continental market share will increase further in the coming years. Further- generally prescribes the investment strategies applied by these more, the first purely electric vehicles that use one or more elec- funds, it does not determine their individual investment alterna- tric motors for propulsion have already been launched. If the in- tives. The assets are invested in different asset classes including dustry is able to develop electric vehicles in line with consumers’ equity, fixed-income securities, real estate and other investment ve- expectations, these could gain a considerable market share in the hicles. The values attributable to the externally invested plan assets medium to long term. are subject to fluctuations in the capital markets that are beyond Continental’s influence. Unfavorable developments in the capital markets could result in a substantial coverage shortfall for these pension obligations, resulting in a significant increase in Continen- tal’s net pension obligations.

104 Continental AG 2017 Annual Report Management Report Report on Risks and Opportunities

Any such increase in Continental’s net pension obligations could Continental depends on a limited number of key suppliers for adversely affect Continental’s financial condition due to an in- certain products. creased additional outflow of funds to finance the pension obliga- Continental is subject to the potential risk of unavailability of certain tions. Also, Continental is exposed to risks associated with longevity raw materials and production materials. Although Continental’s and interest-rate changes in connection with its pension commit- general policy is to source input products from a number of differ- ments, as an interest-rate decrease could have an adverse effect on ent suppliers, single sourcing cannot always be avoided and, conse- Continental’s liabilities under these pension plans. Furthermore, cer- quently, Continental is dependent on certain suppliers in the Rub- tain U.S.-based subsidiaries of Continental have entered into obliga- ber Group as well as with respect to certain products manufactured tions to make contributions to healthcare costs of former employ- in the Automotive Group. Since Continental’s procurement logistics ees and retirees. Accordingly, Continental is exposed to the poten- are mostly organized on a just-in-time or just-in-sequence basis, tial risk that these costs may increase in the future. supply delays, cancellations, strikes, insufficient quantities or inade- quate quality can lead to interruptions in production and, therefore, If the discount rates used to calculate net pension obligations were have a negative impact on Continental’s business operations in to decrease by 0.5 percentage points at the end of the year, ceteris these areas. Continental tries to limit these risks by endeavoring to paribus, this would lead to a rise in net pension obligations in a select suppliers carefully and monitor them regularly. However, if range from €500 million to €600 million, which would not be re- one of Continental’s suppliers is unable to meet its delivery obliga- duced by taking measures to minimize risk. However, this would tions for any reason (e.g. insolvency, destruction of production not affect EBIT. plants or refusal to perform following a change in control), Conti- nental may be unable to source input products from other suppli- Continental is exposed to warranty and product liability ers on short notice at the required volume. The financial and eco- claims. nomic crisis in 2008 and 2009, in addition to the natural disasters Continental is constantly subject to product liability claims and pro- in Japan and Thailand, have shown how quickly the financing ceedings alleging violations of due care, violation of warranty obli- strength and ability of some automotive suppliers to deliver can be gations or material defects, and claims arising from breaches of impaired and even result in insolvency. This mainly affected Tier 2 contract due to recalls or government proceedings. Any such law- and Tier 3 suppliers (suppliers who sell their products to Tier 1 or suits, proceedings and other claims could result in increased costs Tier 2 suppliers respectively), while Tier 1 suppliers (suppliers who for Continental. Moreover, defective products could result in loss of sell their products to OEMs directly) were not affected to the same sales and loss of customer and market acceptance. Such risks are degree. Such developments and events can cause delays in the de- insured up to levels considered economically reasonable by Conti- livery or completion of Continental products or projects and could nental, but its insurance coverage could prove insufficient in indi- result in Continental having to purchase products or services from vidual cases. Additionally, any defect in one of Continental’s prod- third parties at higher costs or even to financially support its own ucts (in particular tires and other safety-related products) could also suppliers. Furthermore, in many cases OEM customers have ap- have a considerable adverse effect on the company’s reputation proval rights with respect to the suppliers used by Continental, and market perception. This could in turn have a negative impact which could make it impossible for Continental to source input on Continental’s sales and income. Moreover, vehicle manufactur- products from other suppliers upon short notice if the relevant ers are increasingly requiring a contribution from their suppliers for OEM customer has not already approved other suppliers at an ear- potential product liability, warranty and recall claims. In addition, lier point in time. All of this could lead to order cancellations or Continental has long been subject to continuing efforts by its cus- even claims for damages. Furthermore, Continental’s reputation tomers to change contract terms and conditions concerning the amongst OEM customers could suffer, with the possible conse- contribution to warranty and recall cost. Furthermore, Continental quence that they select a different supplier. manufactures many products pursuant to OEM customer specifica- tions and quality requirements. If the products manufactured and Continental could be adversely affected by property loss and delivered by Continental do not meet the requirements stipulated business interruption. by its OEM customers at the agreed date of delivery, production of Fire, natural hazards, terrorism, power failures or other disturbances the relevant products is generally discontinued until the cause of at Continental’s production facilities or within Continental’s supply the product defect has been identified and remedied. Under certain chain – with customers and with suppliers – can result in severe circumstances, this can lead to losses of sales and earnings. Further- damage and loss. Such far-reaching negative consequences can more, Continental’s OEM customers could potentially claim dam- also arise from political unrest or instability. The risks arising from ages, even if the cause of the defect is remedied at a later point in business interruption, loss of production, or the financing of facili- time. Moreover, failure to fulfill quality requirements could have an ties are insured up to levels considered economically reasonable adverse effect on the market acceptance of Continental’s other by Continental, but its insurance coverage could prove insufficient products and its market reputation in various market segments. in individual cases. Furthermore, such events could injure or dam- age individuals, third-party property or the environment, which The quantifiable risks from warranty and product liability claims as could, among other things, lead to considerable financial costs for at December 31, 2017, taking into account provisions, amounted Continental. to between €100 million and €200 million.

Continental AG 2017 Annual Report Management Report Report on Risks and Opportunities 105

Continental is exposed to risks in connection with its interest Legal and Environmental Risks in MC Projects B.V. Continental and Compagnie Financière Michelin SCmA, Granges- Paccot, Switzerland (Michelin), each hold a 50% stake in MC Proj- Continental could become subject to additional burdensome ects B.V., Maastricht, Netherlands, a company to which Michelin environmental or safety regulations and additional contributed the rights to the Uniroyal brand for Europe as well regulations could adversely affect demand for Continental’s as for certain countries outside Europe. In turn, MC Projects B.V. products and services. licensed to Continental certain rights to use the Uniroyal brand on As a corporation that operates worldwide, Continental must ob- or in connection with tires in Europe and elsewhere. Under the serve a large number of different regulatory systems in numerous terms of the agreement concluded in this connection, both the countries that change frequently and are continuously evolving agreement and the Uniroyal license can be terminated if a major and becoming more stringent, particularly with respect to the envi- competitor in the tire business acquires more than 50% of the vot- ronment, chemicals and hazardous materials, as well as health reg- ing rights of Continental AG or of its tire business. Furthermore, in ulations. This also applies to air, water and soil pollution regulations this case Michelin also has the right to acquire a majority in MC and to waste legislation, all of which have recently become more Projects B.V. and to have MC Projects B.V. increase its minority stake stringent through new laws, particularly in the EU and the U.S.A. in the manufacturing company Continental Barum s.r.o., Otrokovice, Moreover, Continental’s sites and operations necessitate various Czechia – one of Continental’s largest tire plants in Europe – to 51%. permits and the requirements specified therein must be complied These events could have an adverse effect on the business and with. In the past, adjusting to new requirements has necessitated earnings position of Continental’s Tire division. significant investments and Continental assumes that further signif- icant investments in this regard will be required in the future.

Continental could be unsuccessful in adequately protecting its intellectual property and technical expertise. Continental’s products and services are highly dependent upon its technological know-how and the scope and limitations of its propri- etary rights therein. Continental has obtained or applied for a large number of patents and other industrial property rights that are of considerable importance to its business. The process of obtaining patent protection can be lengthy and expensive. Furthermore, pat- ents may not be granted on currently pending or future applica- tions or may not be of sufficient scope or strength to provide Conti- nental with meaningful protection or commercial advantage. In ad- dition, although there is a presumption that patents are valid, this does not necessarily mean that the patent concerned is effective or that possible patent claims can be enforced to the degree neces- sary or desired.

A major part of Continental’s know-how and trade secrets is not patented or cannot be protected through industrial property rights. Consequently, there is a risk that certain parts of Continental’s know-how and trade secrets could be transferred to collaboration partners, customers and suppliers, including Continental’s machin- ery suppliers or plant vendors. This poses a risk that competitors will copy Continental’s know-how without incurring any expenses of their own. Moreover, Continental has concluded a number of li- cense, cross-license, collaboration and development agreements with its customers, competitors and other third parties under which Continental is granted rights to industrial property and/or know- how of such third parties. It is possible that license agreements could be terminated, under certain circumstances, in the event of the licensing partner’s insolvency or bankruptcy and/or in the event of a change-of-control in either party, leaving Continental with reduced access to intellectual property rights to commercial- ize its own technologies.

106 Continental AG 2017 Annual Report Management Report Report on Risks and Opportunities

There is a risk that Continental could infringe on the industrial of KRW 45,992 million (around €36 million) on Continental Auto- property rights of third parties. motive Electronics LLC, Bugan-myeon, South Korea (CAE). On There is a risk that Continental could infringe on industrial property June 25, 2015, the Seoul High Court, Seoul, South Korea, vacated rights of third parties, since its competitors, suppliers and custom- the administrative fine imposed by the KFTC on CAE’s appeal ers also submit a large number of inventions for industrial property against the amount of the fine. The Supreme Court of South Korea protection. It is not always possible to determine with certainty rejected KFTC’s appeal against this decision on May 31, 2017. It is whether there are effective and enforceable third-party industrial not yet known how high the new fine from the KFTC will be. On No- property rights to certain processes, methods or applications. vember 13, 2014, the competent South Korean criminal court also Therefore, third parties could assert claims (including illegitimate imposed a fine of KRW 200 million (around €157,000). Following ones) of alleged infringements of industrial property rights against CAE’s appeal, this fine was reduced to KRW 100 million (around Continental. As a result, Continental could be required to cease €78,000). The decision is final. On November 24, 2014, CAE and manufacturing, using or marketing the relevant technologies or Continental Automotive Korea Ltd., Seongnam-si, South Korea, en- products in certain countries or be forced to make changes to tered into an agreement in which the two companies admitted to manufacturing processes and/or products. In addition, Continental charges of violating U.S. antitrust law and agreed to pay a fine of could be liable to pay compensation for infringements or could be U.S. $4.0 million (around €3.3 million). The competent U.S. court forced to purchase licenses to continue using technology from confirmed the agreement on April 1, 2015. The risk of investiga- third parties. In addition, Continental is subject to efforts by its cus- tions by other antitrust authorities into this matter and claims for tomers to change contract terms and conditions concerning the damages by alleged victims remain unaffected by the fines im- participation in disputes regarding alleged infringements of intellec- posed. Continental has conducted internal audits in certain busi- tual property rights. ness units to check compliance with antitrust law. These audits re- vealed anticompetitive behavior with respect to product groups. Continental could be threatened with fines and claims for Continental took measures to end this behavior. There is a risk that damages for alleged or actual antitrust behavior. antitrust authorities may conduct investigations due to this behav- In May 2005, the Brazilian competition authorities opened investi- ior and impose fines and that third parties, especially customers, gations against Continental’s Brazilian subsidiary Continental Brasil may file claims for damages. The amount of such fines and any Indústria Automotiva Ltda., Guarulhos, Brazil (CBIA), following a subsequent claims is unknown from the current perspective, but complaint of anticompetitive behavior in the area of commercializa- could be significant. It also cannot be ruled out that future internal tion of tachographs. On August 18, 2010, the Brazilian antitrust au- audits may reveal further actual or potential violations of antitrust thorities determined an “invitation to cartel” and imposed a fine of law that in turn could result in fines and claims for damages. In ad- BRL 12 million (around €3.0 million) on CBIA, which was then dition, alleged or actual antitrust behavior could seriously disrupt reduced to BRL 10.8 million (around €2.7 million). CBIA denies the the relationships with business partners. In September 2014, the accusation that it has infringed Brazilian antitrust law. Although the European Commission conducted a search at a subsidiary of Conti- court of first instance appealed to by CBIA upheld the decision, on nental. The commission has since completed proceedings initiated CBIA’s further appeal the next higher court annulled this decision in this regard and communicated that it is fining Continental AG; and remanded the matter. In case an infringement of Brazilian anti- Continental Teves AG & Co. oHG, Frankfurt, Germany; and Conti- trust law is found, third parties may, in addition, claim damages nental Automotive GmbH, Hanover, Germany; €44.0 million for the from CBIA. unlawful exchange of information. This involved specific brake com- ponents. Continental has set aside provisions that cover this fine. On October 2, 2006, South African antitrust authorities received Continental cannot rule out the possibility that customers will claim a complaint from a third party accusing several South African tire for damages with reference to the commission’s decision. At this manufacturers of alleged antitrust behavior, including Continental point in time, it is not possible to say whether such claims will be Tyre South Africa (Pty.) Ltd., Port Elizabeth (CTSA), a subsidiary of submitted and, if they are, how much the damages will be – irre- Continental. On August 31, 2010, the South African antitrust au- spective of whether or not the claims are justified. As a result, it thorities came to the conclusion that CTSA had violated South cannot be ruled out that the resulting expenses will exceed the pro- African antitrust law and referred the matter to the responsible visions that have been set aside for this purpose. In accordance antitrust court for a decision. CTSA denies the allegation of infringe- with IAS 37.92, no further disclosures will be made with regard to ments of South African antitrust law. However, the tribunal could the proceedings and the related measures so as not to adversely impose a fine of up to 10% of CTSA’s sales. In addition, third parties affect the company’s interests. may also claim damages from CTSA in case of an infringement of South African competition law. Continental is exposed to risks from legal disputes. Companies from the Continental Corporation are involved in a In October 2012, Continental Automotive Systems US, Inc., Auburn number of legal and arbitration proceedings and could become in- Hills, Michigan, U.S.A., and two of Continental’s South Korean sub- volved in other such proceedings in the future. These proceedings sidiaries became aware of investigations by the U.S. Department of could involve substantial claims for damages or payments, particu- Justice (DOJ) and the Korean Fair Trade Commission (KFTC) in con- larly in the U.S.A. For more information on legal disputes, see Note nection with the suspected involvement in violations of U.S. and 32 of the Notes to the Consolidated Financial Statements. South Korean antitrust law in instrument cluster business. On De- cember 23, 2013, the KFTC announced that it had imposed a fine

Continental AG 2017 Annual Report Management Report Report on Risks and Opportunities 107

Material Opportunities

Unless the emphasis is placed on a specific division, then the op- Additional legal regulations with the aim of further improving traffic portunities apply to all divisions. safety would also provide an opportunity for a rise in demand for Continental’s products. We are already among the leading providers There are opportunities for Continental if macroeconomic of electronic brake systems as well as control electronics for airbags development is better than anticipated. and seat belts. Based on our broad product portfolio for active vehi- If the general economic conditions develop better than we have cle safety, we have developed more advanced safety systems over anticipated, we expect that global demand for vehicles, replace- the past years, including , lane departure ment tires and industrial products will also develop better than we warning and blind spot detection systems, as well as the head-up have anticipated. Due to the increased demand for Continental’s display. At present, these systems are mainly optionally installed in products among vehicle manufacturers and industrial clients and luxury vehicles. in the replacement business that would be expected as a conse- quence, sales could rise more significantly than expected and there There are opportunities for Continental from an intensified could be positive effects with regard to fixed cost coverage. trend toward vehicle hybridization. If the trend toward vehicle hybridization intensifies, with the effect There are opportunities for Continental if the sales markets that hybrid technology then represents more of a cost-effective al- develop better than anticipated. ternative than previously expected due to economies of scale, this If demand for automobiles and replacement tires develops better would have a positive impact on Continental, since Continental is than we have anticipated, particularly on the European market, this already well positioned on these future markets with its products. would have positive effects on Continental’s sales and earnings due to the high share of sales generated in this region (49%). There are opportunities for Continental from the intelligent interconnection of vehicles with each other and with the There are opportunities for Continental if there is a stable internet. price level on the raw materials markets relevant to us. By intelligently connecting advanced driver assistance systems and Continental’s earnings situation is affected to a significant extent by driver information systems with each other and with the internet, the cost of raw materials, electronic components and energy. For we are laying the foundations for gradually making automated driv- the Automotive Group divisions, this particularly relates to the cost ing possible in the coming years. We also plan to implement fully of steel and electronic components. If we succeed even better than automated driving in the coming decade by means of collabora- before in offsetting possible cost increases or compensating for tions with leading providers from the technology and internet sec- them through higher prices for our products, this would then have tor. To this end, we are developing new cross-divisional system, ser- a positive effect on Continental’s earnings. The earnings situation of vice and software solutions that can offer substantial growth poten- the Rubber Group divisions is significantly impacted by the cost of tial for Continental with positive effects on its future sales and at- oil and of natural and synthetic rubber. If prices for natural and syn- tainable margins. External studies estimate the market potential of thetic rubber in particular settle down at the level of the second connecting vehicles with each other and with the internet at U.S. half of 2017, this could have a positive impact on Continental’s $70 billion to U.S. $110 billion in 2025. This also includes the intelli- earnings. We currently anticipate that prices, particularly of rubber, gent use of automotive data. This digitalization is opening up a new will rise again over the course of 2018 as a result of the assumed market for mobility services that enables Continental to tap new increase in demand on the global tire-replacement and industrial business areas with its Continental.cloud and eHorizon, which are markets. paving the way for such services. In addition, the increasing digitali- zation of our products gives us the opportunity to offer our custom- There are opportunities for Continental from changes in the ers software-based services as well as the product itself (servitiza- legal framework. tion). Additional sales in these fields would bring Continental closer The further tightening of the regulatory provisions on fuel consump- to achieving its strategic goal of greater independence from the tion and emission standards for motor vehicles in developing mar- automotive industry. kets, too, could trigger higher demand for Continental’s products. With our comprehensive portfolio of gasoline and diesel systems The trend toward automated driving presents Continental including sensors, actuators, exhaust-gas aftertreatment and tailor- with opportunities. made electronics, through to fuel supply systems, engine manage- In recent years, the trend from assisted driving to fully automated ment and transmission control units, down to systems and compo- driving has intensified considerably. Some OEMs expect to be able nents for hybrid and electric drives, as well as with tires with opti- to provide this function in just a few years. A key requirement for mized rolling resistance and tires for hybrid vehicles, we are already fully automated driving is the equipment of vehicle with sensors. providing solutions that enable compliance with such changes in Today, an average of one sensor for assisted driving is installed per the legal framework and can therefore respond quickly to changes vehicle. Merely for partly automated driving, an average of 16 sen- that arise in the regulatory provisions. An increase in the installa- sors are required, including radars, lasers and camera sensors. OEMs tion rates for these products due to increased regulatory provisions estimate that up to 44 sensors are needed in order to realize fully would have a positive influence on our sales and earnings. automated driving. Continental is already one of the leading provid- ers of advanced driver assistance systems. According to our own

108 Continental AG 2017 Annual Report Management Report Report on Risks and Opportunities

estimate, the market volume for sensors for assisted/automated Urbanization presents Continental with opportunities. driving in 2025 will be €35 billion. However, this estimate is based Forecasts predict that by 2050 more than two-thirds of the world’s on far fewer sensors per vehicle than is currently assumed by our population will live in large cities. The vehicle fleet will then have customers. Should the trend toward automated driving continue to grown to over two billion vehicles by that time, and the majority of accelerate in the years to come and the data we assume for sensor these vehicles will be used in large cities. This will pose huge chal- equipment per vehicle prove too conservative, this would result in lenges in terms of infrastructure, safety and vehicle emissions. In considerable sales and earnings opportunities for Continental. view of our broad portfolio of safety technologies, products for zero-emission mobility, and solutions for intelligently connecting vehicles with one another and with the infrastructure, this trend will bring opportunities to generate sales in the future. At the same time, it will also enhance the opportunities arising from digitaliza- tion, electrification and automated driving.

Statement on Overall Risk and Opportunities Situation

In the opinion of the Executive Board, the risk situation of the Conti- However, despite the changes in individual risks, the analysis in nental Corporation has not changed significantly in the past fiscal the corporation-wide risk-management system for the year under year. review did not reveal any risks that, individually or collectively, pose a threat to the company or the corporation as a going concern. In In the current year, it remains to be seen how further political devel- the opinion of the Executive Board, there are also no discernible opments in North America, Europe (e.g. Brexit) and China will affect risks to the corporation as a going concern in the foreseeable the economy and our business development – and whether the future. prevailing volatile situation will affect our company – and, if so, to what extent. Considering the material opportunities, the overall risk assessment for the Continental Corporation presents a reasonable risk and op- portunities situation to which our strategic goals have been aligned accordingly.

Continental AG 2017 Annual Report Management Report Report on Expected Developments 109

Report on Expected Developments Future General Conditions

Forecast of Macroeconomic again after the extensive reforms of recent years. The IMF expects Development growth of 7.4% for India in 2018. The economic recovery in Brazil is also expected to continue this year, with the IMF expecting GDP to increase by 1.9% in 2018. In contrast, it expects growth to de- In its January 2018 World Economic Outlook Update, the Interna- cline slightly in China and Russia. The IMF forecasts GDP growth of tional Monetary Fund (IMF) predicts that growth in Germany and 6.6% for China and 1.7% for Russia in 2018. the eurozone will continue in the current fiscal year, due in particu- lar to consistently good domestic demand. By contrast, the appreci- Based upon these estimates, the IMF expects global economic ation of the euro is likely to dampen exports and foreign trade. For growth to increase by 0.2 percentage points year-on-year to 3.9% 2018, the IMF is now projecting that the gross domestic product in 2018. (GDP) of Germany and the eurozone will grow by 2.3% and 2.2% respectively. However, the IMF points out that the acceleration of growth is mostly based on short-term factors. The IMF sees risks including a For the U.S.A., the IMF expects a significant increase in GDP growth rise in inflation, which would require many central banks to tighten to 2.7% this year. Here, the tax cuts enacted for companies are their expansionary monetary policy. Against the backdrop of in- likely to result in greater investing activity and a revival in domestic creased national and corporate debt and in view of the high valua- demand. Above all, economic activity could be curbed in 2018 by tions on many capital markets, this could have considerable nega- further interest rate hikes by the U.S. Federal Reserve (Fed) and a tive consequences. The IMF also continues to see risks in tenden- higher trade deficit due to increasing imports. cies to put up barriers to trade and in geopolitical tensions between individual countries. At the same time, it points to ongoing struc- The IMF expects moderate growth of 1.2% for Japan in 2018. The tural problems and growing income inequality in some economies main reason for the lower growth compared to 2017 is an antici- and urges appropriate reforms. pated smaller increase in the trade surplus. Low interest rates, which are boosting private investment, and increasing consumer In 2018, the IMF primarily sees opportunities – given the favorable and public spending continue to have a positive effect. financing conditions and positive economic prospects at present – in a greater-than-expected increase in businesses’ investing activi- According to the IMF, emerging and developing economies will re- ties. cord GDP growth of 4.9% in 2018. The increase in growth is mainly being driven by India, whose economy is likely to gain momentum

Sources: IMF – World Economic Outlook Update January 2018, Eurostat, statistical offices of the respective countries, Bloomberg.

110 Continental AG 2017 Annual Report Management Report Report on Expected Developments

Forecast for Key Customer Sectors Forecast for replacement-tire markets for passenger cars and light commercial vehicles The positive trend in demand for replacement tires for passenger Forecast for production of passenger cars and cars and light commercial vehicles weighing less than 6 metric light commercial vehicles tons is expected to continue in all regions in 2018. On a global For the global production of passenger cars and light commercial level, we expect demand to increase by 3%. vehicles weighing less than 6 metric tons, we currently expect growth of more than 1% to 96.5 million units in 2018. The Asian market is expected to contribute around 60% of this with growth of 5%. As in previous years, this will be driven primarily In 2018, we again expect Asia to generate the largest absolute by rising demand in China as a result of the further growth in vehi- growth in production volumes. In our estimation, India, South Korea cle numbers. Demand will also grow in India, Indonesia and South and Iran in particular should record rises in production volumes. We Korea. In Europe, we expect an increase in demand for replace- also currently consider it likely that China’s production will be slight- ment tires for passenger cars and light commercial vehicles in East- ly higher than the previous year’s record level, while we expect a ern Europe in particular in 2018, which is likely to cause sales vol- slight decline in Japan. For Asia as a whole, we anticipate a 2% rise umes in Europe as a whole to increase by 2%. Demand in North in production to around 52.5 million units. We expect passenger-car America is set to recover again after the stagnation in 2017 and production in Europe to grow by 2% in 2018. In Western Europe, increase by 2% in 2018, partly as a result of the continuing rise in apart from the United Kingdom, we anticipate stable development mileage. In South America, we currently expect tire sales volumes of domestic demand. However, the higher euro exchange rate is to increase by 4%. likely to result in lower export figures. In Eastern Europe, passenger- car demand and production are expected to keep recovering. In Forecast for replacement-tire markets for medium and contrast, demand is expected to continue to cool off in North heavy commercial vehicles America, where we consider a 2% decline in production to be Thanks to the growing economy, global demand for replacement probable. In South America, we expect production to increase tires for commercial vehicles weighing more than 6 metric tons is by 8% as a result of the economic recovery. likely to continue increasing in all regions and to rise by over 2% overall in 2018. Forecast for production of medium and heavy commercial vehicles Asia is likely to account for nearly half the expected increase in de- We estimate that global production of commercial vehicles weigh- mand. As a result of rising transport volumes, we currently expect ing more than 6 metric tons will fall short of the previous year’s demand for replacement tires for medium and heavy commercial level in 2018. vehicles to increase by 2%. We also currently expect sales volumes to increase by 2% in Europe. At present, we consider 3% growth in After the sharp rise in the previous year, we expect a considerable demand in North America to be realistic. In South America, we cur- decline in production in China in 2018. As a result, we expect a 5% rently expect demand for replacement tires for medium and heavy decrease in production in Asia. In contrast, the expected economic commercial vehicles to go up by 5%. development in most countries is likely to lead to rising demand and increasing production. We expect production to increase by 2% in Europe and 9% in North America. We currently anticipate growth of 10% for South America.

Forecast for vehicle production and sales volumes in the tire-replacement business

Vehicle production Replacement sales of tires of passenger cars and of medium and heavy for passenger cars and for medium and heavy light commercial vehicles commercial vehicles light commercial vehicles commercial vehicles in millions of units in thousands of units in millions of units in millions of units

2018 2017 2018 2017 2018 2017 2018 2017 Europe 22.5 22.1 673 660 358 351 25.8 25.3 North America 16.8 17.1 559 513 290 285 25.3 24.5 South America 3.6 3.3 112 102 76 73 16.4 15.7 Asia 52.5 51.5 2,033 2,140 475 453 91.0 89.2 Other markets 1.1 1.1 0 0 48 47 7.8 7.8

Worldwide 96.5 95.1 3,377 3,415 1,247 1,208 166.3 162.5

Sources: Vehicle production: IHS Inc. (Europe with Western, Central, and Eastern Europe incl. Russia and Turkey; Asia incl. Kazakhstan, Uzbekistan, Middle East and Oceania with Australia). Tire replacement business: LMC International Ltd. Preliminary figures and own estimates.

Continental AG 2017 Annual Report Management Report Report on Expected Developments 111

Outlook for the Continental Corporation

Forecast process term targets of the Rubber Group. Accordingly, we want to gener- Continental reports its expectations regarding the development of ate sales of more than €50 billion and a return on capital employed the important production and sales markets already in January of (ROCE) of at least 20% in 2020. These medium-term targets were the current fiscal year. This forms the basis of our forecast for the confirmed again after the review in 2017. corporation’s key performance indicators, which we publish at the same time. These include sales and the adjusted EBIT margin for Comparison of the past fiscal year against forecast the corporation. In addition, we provide information on the assess- We achieved all and even significantly exceeded some aspects of ment of important factors influencing EBIT. These include the ex- the forecast compiled in February 2017. pected negative or positive effect of the estimated development of raw materials prices for the current year, the expected develop- On the basis of the good business development, the forecast for ment of special effects and the amount of amortization from pur- consolidated sales was raised in the first-quarter reporting in May chase price allocation. We thus allow investors, analysts, and other 2017 and the reporting on the first half of the year in August 2017. interested parties to estimate the corporation’s EBIT. Furthermore, With consolidated sales of €44.0 billion, the original forecast was we publish an assessment of the development of interest income exceeded by more than €1 billion. and expenses as well as the tax rate for the corporation, which in turn allows the corporation’s net income to be estimated. We also The forecast for the corporation’s adjusted EBIT margin of more publish a forecast of the capital expenditures planned for the cur- than 10.5% was maintained over the entire forecast period. It was rent year and the free cash flow before acquisitions. In February of 10.9% at the end of the reporting year and thus considerably the current fiscal year, we supplement this forecast for the corpora- higher than the forecast target value. tion with a forecast of the sales and adjusted EBIT margins of the two core business areas: the Automotive Group and the Rubber The sales forecast for the Automotive Group was likewise revised Group. We then publish this forecast in March as part of our annual upward twice over the course of the reporting year, first in the first- financial press conference and our annual report for the previous quarter reporting in May 2017 and then again in the reporting on year. The forecast for the current year is reviewed continually. Possi- the first half of the year in August 2017. At €26.6 billion, the Auto- ble changes to the forecast are described at the latest in the finan- motive Group’s sales were considerably higher than the original cial report for the respective quarter. At the start of the subsequent forecast of around €26 billion. This was due to the better-than- year, i.e. when the annual report for the previous year is prepared, expected volume development in all divisions of the Automotive a comparison is made with the forecast published in the annual re- Group. port for the year before. The forecast for the Automotive Group’s adjusted EBIT margin was In 2015, Continental compiled a medium-term forecast in addition maintained over the entire forecast period. At 8.4%, it was in line to the targets for the current year. This comprises the corporate strat- with the forecast of approximately 8.5%. egy, the incoming orders in the Automotive Group and the medium-

Comparison of fiscal 2017 against forecast

Corporation Automotive Group Rubber Group Capital Adjusted expenditure Free Adjusted Adjusted Sales1 EBIT margin in % of sales cash flow2 Sales1 EBIT margin Sales1 EBIT margin January 2017 >€43 billion >10.5% ~6.5% ~€2 billion 2016 Annual Report >€43 billion >10.5% ~6.5% ~€2 billion ~€26 billion ~8.5% >€17 billion >15% Financial Report as at March 31, 2017 >€43.5 billion >10.5% ~6.5% ~€2 billion >€26 billion ~8.5% >€17 billion >15% Half-Year Financial Report as at June 30, 2017 >€44 billion >10.5% ~6.5% ~€2 billion ~€26.5 billion ~8.5% >€17 billion >15% Financial Report as at September 30, 2017 >€44 billion >10.5% ~6.5% ~€2 billion ~€26.5 billion ~8.5% >€17 billion >15% 2017 reported €44.0 billion 10.9% 6.5% €2.3 billion €26.6 billion 8.4% €17.5 billion 15.6%

1 Assuming exchange rates remain constant year-on-year. The negative exchange-rate effects for the corporation amounted to €435 million in 2017. Around two-thirds of this was attributable to the Automotive Group, around one-third to the Rubber Group. 2 Before acquisitions.

112 Continental AG 2017 Annual Report Management Report Report on Expected Developments

The sales forecast of more than €17 billion for the Rubber Group Outlook for the Continental Corporation was maintained at all times during the reporting year. With sales For fiscal 2018, we anticipate an increase in global light-vehicle of €17.5 billion, the original forecast was exceeded. This was due production (passenger cars, station wagons and light commercial firstly to the earlier-than-expected first-time consolidation of the vehicles) of more than 1% to 96.5 million units. We expect demand Hornschuch Group and secondly to the good volume development on our key replacement-passenger-tire markets – Europe and North in the Tire and ContiTech divisions. America – to grow by a total of 12 million replacement tires or 2% in each case. Based on these market assumptions and provided The forecast for the Rubber Group’s adjusted EBIT margin was that exchange rates remain constant, we anticipate an increase in maintained over the forecast period. At 15.6%, it was ultimately consolidated sales to around €47 billion in 2018. above the original forecast of more than 15%. We have set ourselves the goal for the corporation of achieving a The negative financial result increased in the reporting year despite consolidated adjusted EBIT margin of around 10.5% for fiscal the good development of free cash flow. This was due to effects 2018. With regard to the development of the adjusted EBIT margin, from currency translation, as well as effects from changes in the the lower expectation in comparison to the previous year is attri- fair value of derivative instruments, and other valuation effects. Al- butable mainly to the expected additional expenses due to the ris- together, these had a negative impact of €98.6 million (PY: positive ing fixed costs in the Tire division and additionally due to rising raw impact of €90.4 million) on the reported financial result in 2017. material costs in the Rubber Group. The increase in fixed costs in Adjusted for these effects, the negative financial result of €187.1 the Tire division has resulted primarily from the considerable ex- million was in line with the forecast we compiled at the start of the pansion of capacity over recent years. In 2017, this already led to year of around €200 million assuming constant exchange rates. an increase in depreciation and amortization of around €60 million The tax rate of 28.7% was slightly below our forecast of less than year-on-year. This year, the startup of the tire plants in Clinton, Mis- 30%. sissippi, U.S.A., and in Rayong, Thailand, is expected to result in a further rise in depreciation and amortization, but also other fixed As in the previous year, the free cash flow before acquisitions was costs, before these two plants generate their first sales. We estimate €2.3 billion despite the slightly increased capital expenditure ratio these costs alone at around €120 million. For the Automotive Group, and the partial outflows for the provisions for warranty cases in the assuming constant exchange rates, we anticipate sales growth of Automotive Group recognized in 2016. 7% to approximately €28.5 billion with an adjusted EBIT margin of around 8.5%. For the Rubber Group, assuming constant exchange Order situation rates, we expect sales growth to approximately €18.5 billion with The Automotive Group continued to experience a positive trend an adjusted EBIT margin of around 15%. in incoming orders in the past fiscal year. All three Automotive divi- sions considerably increased their goods on order compared to In 2018, we anticipate a negative effect of approximately €50 mil- the previous year. Altogether, the Chassis & Safety, Powertrain and lion from the rising prices of raw materials in the Rubber Group. Interior divisions acquired orders for a total value of nearly €40 bil- This is based on the assumption of an average price of U.S. $1.84 lion for the entire duration of the deliveries for the vehicles. These per kilogram (2017: U.S. $1.67 per kilogram) for natural rubber lifetime sales are based primarily on assumptions regarding pro- (TSR 20) and U.S. $1.60 per kilogram (2017: U.S. $1.51 per kilo- duction volumes of the respective vehicle or engine platforms, the gram) for butadiene, a base material for synthetic rubber. We also agreed cost reductions, and the development of key raw materials expect costs for carbon black and other chemicals to increase by prices. The volume of orders calculated in this way represents a ref- at least 10% compared to the average prices in 2017. For the Rub- erence point for the resultant sales achievable in the medium term ber Group, every U.S. $10 increase in the average price of crude oil that may, however, be subject to deviations if these factors change. equates to a negative annual gross effect on EBIT of around U.S. Should the assumptions prove to be correct, the lifetime sales are $50 million. The average price of North Sea Brent was around U.S. a good indicator for the sales volumes that can be achieved in the $54 in 2017. Automotive Group in four to five years. In 2018, we expect the negative financial result before effects from The replacement tire business accounts for a large portion of the currency translation, effects from changes in the fair value of deriv- Tire division’s sales, which is why it is not possible to calculate a reli- ative instruments, and other valuation effects to be less than €180 able figure for order volumes. The same applies to the ContiTech million. The tax rate should again be less than 30% in 2018. division, which since January 2018 has comprised seven business units operating in various markets and industrial sectors, each in For 2018, we expect negative special effects to total €100 million. turn with their own relevant factors. Consolidating the order figures Amortization from purchase price allocations, resulting primarily from the various ContiTech business units would thus be meaning- from the acquisitions of Veyance Technologies (acquired in 2015), ful only to a limited extent. Elektrobit Automotive (acquired in 2015), and the Hornschuch Group (acquired in 2017), is expected to total approximately €180 million and to affect mainly the ContiTech and Interior divisions.

Continental AG 2017 Annual Report Management Report Report on Expected Developments 113

In fiscal 2018, the capital expenditure ratio before financial invest- emphasis will be on the expansion of production capacity in East- ments will increase to around 7% of sales. Approximately 60% of ern Europe and North America. In the ContiTech division, invest- capital expenditure will be attributable to the Automotive Group ments will continue to concentrate on the relocation of a plant in and 40% to the Rubber Group. the Mobile Fluid Systems business unit and the expansion of pro- duction in the Benecke-Hornschuch Surface Group business unit The largest projects within the Chassis & Safety division in 2018 re- in China. main the global expansion of production capacity for the MK 100 and for the MK C1 brake generations in the Vehicle Dynamics busi- As at the end of 2017, Continental’s net indebtedness amounted ness unit. In addition, major investments are planned for the global to €2.0 billion. In the future, we intend to continue strengthening in- expansion of capacity for long- and short-range radar sensors as dustrial business in particular, in line with our objective of reducing well as for 360-degree and multi-function cameras in the Advanced our dependency on the automotive original-equipment sector. The Driver Assistance Systems business unit. Initial investments will also acquisition of further companies for this purpose has not been ruled be made in increasing the production of high-resolution 3D lidar out. Another focus will be the selective reinforcement of our tech- sensors. The Powertrain division is planning investments in a new nological expertise in future-oriented fields within the Automotive plant in China. Investments in the Hybrid Electric Vehicle business Group. unit are also a priority of the investment program. Besides invest- ments in capacity for electric motors, capital expenditure is planned For 2018, we are planning on free cash flow of approximately €2 to increase production of 48V belt-driven starter generators. The billion before acquisitions. One reason for this year-on-year decrease Interior division is investing in the construction of new plants in is an increase in the capital expenditure ratio. In addition, we expect Eastern Europe and North America and the expansion of R&D the rest of the warranty provisions recognized in 2016 and the pro- capacity at certain European locations. vision recognized in 2016 for potential antitrust fines to flow out in full in 2018. In the Tire division, investments in 2018 will focus on the expan- sion of passenger tire production in Southern and Eastern Europe, The start to 2018 has confirmed our expectations for the full year. Asia, and North America. In the area of commercial-vehicle tires, the